Companies with excess cash often employ share repurchase plans in place of or al
ID: 2793605 • Letter: C
Question
Companies with excess cash often employ share repurchase plans in place of or along with cash dividends. Share repurchase plans can help investors liquidate their holdings by selling their stock to the issuing company and earning from capital gains Consider the case of St. Sebastian Inc.: St. Sebastian Inc. has forecasted a net income of $5,700,000 for this year. Its common stock currently trades at $22 per share, and the company currently has 790,000 shares of common stock outstanding. It has sufficient funds available to pay a cash dividend, but many of its investors don't like the additional tax liability to which the dividend income subjects them As a result, St. Sebastian's management is considering making a share repurchase transaction in which it would buy back 80,000 shares of its outstanding shares in the open market by paying the current market share price. Assume that the repurchase transaction will have no effect on either the company's net income or its price-to-earmings (P/E) ratio. What is St. Sebastian's expected stock price after the stock repurchase transaction? O $24.49 per share $25.71 per share O $23.27 per share $29.39 per share Which of these factors are considered an advantage of a stock repurchase? Check all that apply. when a firm distributes cash by repurchasing stock, stock. Stockholders who sell their stock back to the company might claim that they were not made fully aware of all implications of the repurchase. The firm might pay too high a price for the repurchased stock. stockholders have the option to either sell or not sellExplanation / Answer
1) EPS pre - repurchase = Net Income / No. of shares = $5,700,000 / 790,000 = $7.22
P/E ratio = MPS / EPS = $22 / $7.215 = 3.05 times
The P/E ratio and net income will remain the same post repurchase.
No. of shares post repurchase = 790,000 - 80,000 = 710,000 shares
EPS post repurchase = $5,700,000 / 710,000 = $8.03
Market price post repurchase = EPS post repurchase x P/E ratio = $8.03 x 3.05 = $24.49
2) Option 1 is the correct answer as the shareholders can either sell the shares for a capital gain or can hold it for dividends in future as they would have this option in a repurchase.
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