The balance sheet for Chevelle Corp. is shown here in market value terms. There

Question

The balance sheet for Chevelle Corp. is shown here in market value terms. There are 9,000 shares of stock outstanding.   

The company has declared a dividend of $ 1.40 per share. The stock goes ex divi-dend tomorrow. Suppose Chevelle has an-nounced it is going to repurchase $ 12,600 worth of stock. What effect will this transaction have on the equity of the fi rm? How many shares will be outstanding? What will the price per share be after the repurchase? Ignoring tax effects, show how the share repurchase is effectively the same as a cash dividend.

Market Value Balance Sheet Cash 43,700 Equity 353,700 Fixed Assets 310.000 Total 353,700 353,700

Explanation / Answer

Chevelle announcement of repurchasing stock worth $12600 would not let the share price drop after the stock goes ex-dividend. Otherwise, normally, the market discounts the share price by the amount of forgo dividend.

After, the repurchase of stock, the outstanding shares are =

Per share market price = 353700/9000 = $39.30 per share

Stock repurchased = 12600 / 39.30 = 321 shares

shares will be outstanding = 9000 - 321 = 8679 shares

the price per share be after the repurchase = (353700 -12600) / 8679 = $39.30 per share

If we ignore the tax effects, the share repurchase is as effective as a cash dividend because the effective shares outstanding get reduced, which will provide the existing stockholders higher EPS and Cash Dividend per share in the future.

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