A company has been paying a regular cash dividend of $4 per share each year for

Question

A company has been paying a regular cash dividend of $4 per share each year for over a decade. The company is paying all its earnings as dividends and is not expected to grow. There are 100,000 shares outstanding selling for $80 per share. The company has sufficient cash on hand to pay the next year dividend. Suppose the company decides to cut its cash dividend to zero and announces it will repurchase shares instead

What is the immediate stock price reaction?

How many shares will the company purchase next year instead of paying dividends?

What are the future stock prices for the old and new rules for (year 1, 2 and 3)

Explanation / Answer

What is the immediate stock price reaction? If we ignore taxes, the share price will be $80 How many shares will the company purchase next year instead of paying dividends Dividend per share = $4 Total Dividend to be paid $4*100000 shares =$4,00,000 Cash available = total dividend = $400000 Price per share = $80 Noof shares that can be purchased = $4,00,000/$80per share = 5000 shares What are the future stock prices for the old and new rules for (year 1, 2 and 3) Total asset value (before each dividend payment or stock repurchase) remains at$8,000,000.These assets earn $400,000 per year under either policy. Old Policy:The annual dividend is $4, which never changes, so the stock price(immediately prior to the dividend payment) will be $80 in all years. New Policy: Every year, $400,000 is available for share repurchase. As noted above,5,000 shares will be repurchased att= 0. Att= 1, immediately prior to the repurchase,there will be 95,000 shares outstanding. These shares will be worth $8,000,000, or$84.21 per share. With $400,000 available to repurchase shares, the total number ofshares repurchased will be 4,750. Using this reasoning, we can generate the followingtable: time Outstanding Shares SharePrice ($80,00,000/no of shares) Shares Re purchased t=0 100000 80 5000 ($400000/80) t=1 95000                          84.21 4750 ($400000/84.21) t=2 90250                          88.64 4513 ($400000/88.64) t=3 85737                          93.31 4287 ($400000/93.31)

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