Question

XYZ Co. is all equity financed. The equity consists of 1000 common shares with a market...

XYZ Co. is all equity financed. The equity consists of 1000 common shares with a market value of $10 per share.
Management is considering three mutually exclusive uses of $1000 in cash that is not needed for working capital.
What will be the market price of XYZ's common stock, the number of shares outstanding, and the value of the firm
immediately after each of these alternatives? Ignore tax considerations.
a) Pay a cash dividend of $1 per share.
b) Use the $1000 to repurchase common shares in the market.
c) Invest $1000 in a new (previously unanticipated) investment project whose NPV is
known to equal $200.
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Answer #1

a. When a dividend of $1 is paid, the price of the stock reduces by the amount of dividend and hence the new price will be $10-1 = $9

Price = $9, Number of shares = 1000, Market value of stock = 9*1000 = 9,000

b. When there is the repurchase of shares

No. of shares repurchased = 1000/10 = 100

Number of shares outstanding = 1000 -100 = 900 shares

Price remains unchanged at $10

Market value = 900*10 = $9,000

c. Anticipated value = 200

Expected Incerase in share price = 200/1000 = 0.2

New share price = $10.2

Number of shares = 1000

Market value = 10.2*1000 = $10,200

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