Question

Campbell Corporation is evaluating an extra dividend versus a share repurchase. In either case, $19,000 would be spent. Current earnings are $1.60 per share, and the stock currently sells for $50 per share. There are 2,500 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.)

Alternative I	Extra dividend
Price per share	$
Shareholder wealth	$

Alternative II	Repurchase
Price per share	$
Shareholder wealth	$

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.)

Alternative 1
EPS	$
PE ratio

Alternative II
EPS	$
PE ratio

Answer 1

Answer a: If the company makes dividend payment, we can calculate shareholder's wealth as:

Dividend per share= Amount to be spent÷ No. of shares outstanding

= 19000/2500

= $ 7.6 per share

Revised stock price = $50 - $7.60

= 42.40

Shareholders Wealth= Market price of stock + Dividend

= 42.40 + 7.60

= $ 50

b. EPS = $2.50; Price = 42.40

PE Ratio: Price/ EPS

= 42.40/ 2.50

= 16.96

Alternate II: If the company repurchases stock

No. of shares that can be purchased = Amount available÷ Price per share

= 19000÷ 50 = 380

If shareholders let their shares be repurchased they will have $50 in cash and if they hold back the stock is still worth $50.

Therefore, shareholders wealth is $50.

Earnings per share= Total Earnings ÷ No.of shares

= (1.60× 2500) ÷ (2500+ 380)

= $ 1.39

PE Ratio: Price÷ ESP

= 50 ÷ 1.39 = 35.97