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:

Q.1.1 Name and explain any two ways that Archer Limited can execute a share buy‐back. (6)

Q.1.2 Calculate the net profit after tax. (3)

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

1.1 Normally there are four types of methods of buy back of shares. They are

1. Open market stock buy backs

2. Fixed price tender offer

3. Dutch auction tender offer

4. Direct negotiation with shareholders.

Here the most important two ways or methods by Archer limited can execute a share buy-back is

1. Open market stock buy back

A company buys back its shares directly from the market. The transactions are executed via the company’s brokers. The buyback of shares generally happens over a long period of time as a large number of shares must be bought. At the same time, unlike other methods, stock buybacks via open market do not impose any legal obligations on a company to complete the buyback program.

A company buys back its shares directly from the market. The transactions are executed via the company’s brokers. The buyback of shares generally happens over a long period of time as a large number of shares must be bought. At the same time, unlike other methods, stock buybacks via open market do not impose any legal obligations on a company to complete the buyback program.

2. Fixed price tender offer

A company buys back its shares directly from the market. The transactions are executed via the company’s brokers. The buyback of shares generally happens over a long period of time as a large number of shares must be bought. At the same time, unlike other methods, stock buybacks via open market do not impose any legal obligations on a company to complete the buyback program.

1.2 Earnings = 36×4.5

= 159

If tax rate is 50%

Net profit after tax = 159×(0.5)

= 80

So Net profit after tax is 80