Question

Question 1 (Marks: 15) Archer Limited is expected to trade at a price earnings ratio of 4,5. The market price per share is expected to be R36 before the dividend payment and the price‐earnings (P/E) ratio is based on this price. The company has 1 250 000 shares in issue. Archer Limited’s goal is not to expand its operations, but rather to keep its capital investment equivalent to the current depreciation charge. The company’s earnings are expected to remain constant for the foreseeable future. Management is deciding whether to distribute all its net income for the year as a dividend, or to engage in a share buy‐back at the current price, inclusive of the expected dividend. Neither decision is expected to have any impact on the P/E ratio. REQUIRED:

Q1.1 DONE

Q1.2 DONE

Q.1.3 Calculate the total number of shares to be repurchased. Round off your answer to the nearest whole number. (3)

Q.1.4 Calculate the number of shares in issue after the buy‐back. (1)

Q.1.5 Calculate the expected share price after the share buy‐back (2). Round off your answer to two decimal places.

Answer 1

1.3:

PE ratio = 4.5

Market Price = R36

Shares Outstanding = 1250000

EPS = Market Price / PE ratio i.e. 36/4.5 = R 8

Total earnings = shares outstanding * EPS i.e. 8*1250000 = R 10000000

Shares to be repurchased = Total earnings / Current Market price i.e. 10000000/36 = 277778 shares

1.4:

Shares in issue after buyback = 1250000-277778 = 972222 shares

1.5:

Expected share price after buyback = PE ratio * EPS

EPS = Earnings / Shares in issue i.e. 100000000/972222 = 10.29

Expected share price = 4.5*10.29 = R 46.31