Question

Gamma Industries has net income of $1,000,000, and it has 1,865,000 shares of common stock outstanding. The company's stock currently trades at $33 a share. Gamma is considering a plan in which it will use available cash to repurchase 15% of its shares in the open market at the current $33 stock price. The repurchase is expected to have no effect on net income or the company's P/E ratio. What will be its stock price following the stock repurchase? Do not round intermediate calculations. Round your answer to the nearest cent.

Answer 1

Earnings Per Share = Net Income / Shares Outstanding

So existing Earnings Per Share = 1,000,000/1,865,000 = .54

It has given that current stock price is $33.

So Price-Earnings Ratio = Price per Share / Earnings per Share

Price-Earnings Ratio = 33/.54 =61.11

Shares After Repurchase of 15% shares = 1865,000 - ( 1865000* 15% )

=15,85,250

Since the net income remains the same, we can calculate the earnings per share after repurchase.

Earnings Per Share After Repurchase = 1,000,000/15,85,250 =.63

Since the price-earnings ratio remains the same at 61.11, the stock price after repurchase is calculated as follows

Price Per Share = Price-Earnings Ratio * Earnings per Share

Price Per Share after repurchase = 61.11*.63 =38.50