Question

Awake Corporation is evaluating an extra dividend versus a share repurchase. In either case, $14,000 would be spent. Current earnings are $2.00 per share, and the stock currently sells for $50 per share. There are 2,000 shares outstanding. Ignore taxes and other imperfections.

a.	Evaluate the two alternatives in terms of the effect on the price per share of the stock and shareholder wealth per share. (Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.)(Show work)

b.	What will the company's EPS and PE ratio be under the two different scenarios? (Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.)(Show work)

Answer 1

a. Alternative 1: Extra dividend

.Dividend per share (DPS) = Amount spent / No. of shares = $14000/2000 = $7

Stock price after dividend payment = Current price - DPS = $50-$7 =$43

Shareholders wealth = Stock price after dividend payment + Dividend per share = $43+$7 = $50

Alternative 2 : Share repurchase

Shares repurchased = $14000 /$50 =280 shares

Share holders wealth will be $50 in cash

b. EPS and P/E ratio

Alternative 1 : Extra dividend

EPS = $2

P/E ratio = Share price /Eps =43/2 =21.5

Alternative 2 : Share repurchase

EPS = 2*2000 / (2000-280) = 4000/1720 = $2.33

P/E ratio = $50 /$2.33 = $21.46