Galles Corporation is evaluating an extra dividend versus a

Galles Corporation is evaluating an extra dividend versus a share repurchase. In either case, $15,000 would be spent. Current earnings are $2.50 per share, and the stock currently sells for $50 per share. There are 4,000 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. Round your answers to 2 decimal places, e.g., 32.16.) Alternative l Extra dividend Price per share Shareholder wealth Alternative lI Repurchase Price per share Shareholder wealth b. What will the company\'s EPS and P/E ratio be under the two different scenarios? (Do not round intermediate calculations. Round your final answers to 2 decimal places, e.g., 32.16.) Alternative1 EPS P/E ratio Alternative lI EPS P/E ratio

Solution

Answer:

a) Alternative 1: Extra Dividend

Price Per Share : $ 46.25

Shareholder Wealth: $50

Alternative 2: Repurchase

Price Per Share : $ 50

Shareholder Wealth: $50

b) Alternative 1

EPS: $ 2.50

P/E Ratio: 18.50

Alternative 2

EPS: $ 2.70

P/E Ratio: 21.48

Solution:

a) Alternative 1

Evaluation of Payment of Extra Dividend on Price Per Share and shareholder wealth:

Total Number of Shares outstanding = 4000

Extra Amount Available with the company = $ 15000

Extra Dividend Per Share= $15000/ 4000= 3.75

Price Per share after payment of dividend= Current Price - Extra Dividend Payment

Price per share= $50-$3.75= $ 46.25

Shareholder wealth = Price Per Share after dividend payment + Dividend Amount

Shareholder wealth= $46.25+ $ 3.75= $50

Alternative 2:

Evaluation of Stock Repurchase on Price Per Share and shareholder wealth:

No. of Shares can repurchase= Amount available for spent/ Current Price per share

= $15000/$50= 300 shares

If the shareholder\'s shares purchased, they will have $50 in cash and if they keep shares, wealth will be same i.e. $ 50.

b) Alternative 1

Evaluation of Company EPS and PE Ratio after Payment of Extra Dividend  

If the company pays dividend , the current EPS is $ 2.50 and the P/E Ratio = MPS/ EPS

P/E Ratio= $ 46.25/$ 2.50 = 18.50

Alternative 2:

Evaluation of Company EPS and PE Ratio after Repurchase of shares

EPS= EPS*No. of shares outstanding/ No of Shares after repurchasei.e. new shares o/s

EPS= $2.50*4000/(4000-300)

EPS= 10000/3700= $ 2.70

The stock price will remain at $ 50 per share , P/E Ratio is MPS/EPS= 58/2.70= 21.48