Question

St. Sebastian Company has forecasted a net income of $5,100,000 for this year. Its common stock currently trades at $22 per share, and the company currently has 720,000 shares of common stock outstanding. It has sufficient funds available to pay a cash dividend, but many of its investors don't like the additional tax liability to which the dividend income subjects them.

As a result, St. Sebastian’s management is considering making a share repurchase transaction in which it would buy back 70,000 shares of its outstanding shares in the open market by paying the current market share price. Assume that the repurchase transaction will have no effect on either the company's net income or its price-to-earnings (P/E) ratio. What is St. Sebastian's expected stock price after the stock repurchase transaction? (Note: Round your intermediate calculation to two decimal places. Round your answer to two decimal places.)

a.) $31.73 per share

b.) $24.41 per share

c.) $28.07 per share

d.) $29.29 per share

Which of these factors are considered an advantage of a stock repurchase? Check all that apply.

1. The price of the firm’s stock might benefit more from cash dividends than from a repurchase.

2. Repurchases can be used to produce large-scale changes in capital structure.

3. A repurchase can remove a large block of stock that is overhanging the market and keeping the per-share price depressed.

Answer 1

Current Earnings per share = Net Income/Number of shares outstanding

= 5,100,000/720,000

= $7.0833 per share

P/E Ratio = Market price/EPS

= 22/7.0833

= 3.1059 times

EPS after repurchase = 5,100,000/650,000

= $7.8462

Price = 7.8462*3.1059 = $24.37 per share

i.e. B $24.41 per share approx.

Advantages are:

2. Repurchases can be used to produce large-scale changes in capital structure.

3. A repurchase can remove a large block of stock that is overhanging the market and keeping the per-share price depressed.

First one is a disadvantage