Corporate Finance【Reading 39】Sample 2012, increase

kim226

Paying a cash dividend is most likely to result in:

A) an increase in financial leverage ratios.

B) an increase in liquidity ratios.

C) the same impact on liquidity and leverage ratios as a stock dividend.

---

A cash dividend will increase leverage ratios such as debt-to-equity and debt-to-assets, reflecting a decrease in the denominator. A cash dividend should decrease liquidity ratios such as the current ratio and cash ratio, due to the decrease in cash in the numerator. Unlike a cash dividend, a stock dividend or a stock split has no impact on liquidity or financial leverage ratios.

terpsichorefan

thanks for sharing

karoliukas

Pearl City Breweries has 8 million shares outstanding that are currently trading at $34 per share. The company is choosing whether to distribute $22 million as dividends or to use the same amount to repurchase its shares. Ignoring tax effects, what will be the amount of total wealth from owning one share of Pearl City Breweries under each of these alternatives?

Cash dividend

Share repurchase

A) $34.00 $34.00

B) $31.25 $37.00

C) $31.25 $34.00

---

If the company pays a cash dividend, the dividend per share will be $22 million/8 million = $2.75. The value of its shares will be:

So the total wealth from owning one share will be $31.25 + $2.75 = $34.00.
If the company repurchases shares, it can buy $22 million/$34 = 647,058 shares. The value of one share would then be:

If you remember that both a cash dividend and a share repurchase for cash leave shareholder wealth unchanged, this question does not require calculations of the amounts.

karoliukas

What is the impact on shareholder wealth of a share repurchase versus cash dividend of equal amount when the tax treatment of the two alternatives is the same?

A) A share repurchase will sometimes lead to higher total shareholder wealth than a cash dividend of an equal amount.

B) A share repurchase is equivalent to a cash dividend of an equal amount, so total shareholder wealth will be the same.

C) A share repurchase will always lead to higher total shareholder wealth than a cash dividend of an equal amount.

---

Assuming that the tax treatment of a share repurchase and a cash dividend of equal amount is the same, a share repurchase is equivalent to a cash dividend payment, and shareholder wealth will be the same.

karoliukas

The share price of Winnipeg Auto Unlimited is $5 per share. There are 50 million shares outstanding, and Winnipeg has a book value of $900 million. What is the book value per share (BVPS) after the share repurchase of $10 million?

A) $21.24.

B) $18.54.

C) $14.76.

---

The share buyback is $10 million / $5 per share = 2,000,000 shares.
Remaining shares: 50 million − 2 million = 48 million shares.
Winnipeg Auto Unlimited’s current BVPS = $900 million / 50 million = $18.
Book value after repurchase: $900 million − $10 million = $890 million.
BVPS = $890 million / 48.0 million = $18.54.
BVPS increased by $0.54.

Book value per share (BVPS) increased because the share price is less than the original BVPS. If the share prices were more than the original BVPS, then the BVPS after the repurchase would have decreased.

karoliukas

The share prices of Solar Automotive Industries and Winnipeg Auto Unlimited are both $50 per share, and each company has 50 million shares outstanding. On September 30, both companies announced a $10 million stock buyback. Solar has a book value of $500 million, while Winnipeg has a book value of $900 million. How much did the book value per share (BVPS) of each company increase or decrease after the share repurchase?

Solar Automotive Industries

Winnipeg Auto Unlimited

A) Decrease by $0.16 Decrease by $0.13

B) Decrease by $0.13 Decrease by $0.13

C) Increase by $0.13 Increase by $0.16

---

The share buyback for each company is $10 million / $50 per share = 200,000 shares.
Remaining shares for each company = 50 million − 200,000 = 49.8 million shares.
For Solar Automotive Industries:
Solar Automotive Industries’ current BVPS = $500 million / 50 million = $10.
The market price per share of $50 is greater than the BVPS of $10.
Book value after repurchase = $500 million – $10 million = $490 million
BVPS = $490 million / 49.8 million = $9.84
BVPS decreased by $0.16
For Winnipeg Auto Unlimited:
Winnipeg Auto Unlimited’s current BVPS = $900 million / 50 million = $18.
The market price per share of $50 is greater than the BVPS of $18.
Book value after repurchase = $900 million – $10 million = $890 million
BVPS = $890 million / 49.8 million = $17.87
BVPS decreased by $0.13.

In the case of both Solar Automotive Industries and Winnipeg Auto Unlimited, book value per share (BVPS) decreased because the share price is greater than the original BVPS. If the share prices were less than the original BVPS, then the BVPS after the repurchase for each firm would have increased.

karoliukas

The share price of Solar Automotive Industries is $50 per share. It has a book value of $500 million and 50 million shares outstanding. What is the book value per share (BVPS) after a share repurchase of $10 million?

A) $10.12

B) $10.00.

C) $9.84.

---

The share buyback is $10 million / $50 per share = 200,000 shares.
Remaining shares: 50 million − 200,000 = 49.8 million shares.
Solar Automotive Industries’ current BVPS = $500 million / 50 million = $10.
Book value after repurchase: $500 million − $10 million = $490 million.
BVPS = $490 million / 49.8 million = $9.84.
BVPS decreased by $0.16.

Book value per share (BVPS) decreased because the share price is greater than the original BVPS. If the share prices were less than the original BVPS, then the BVPS after the repurchase would have increased.

karoliukas

Sinclair Construction Company’s Board of Directors is considering repurchasing $30,000,000 worth of common stock. Sinclair assumes that the stock can be repurchased at the market price of $50 per share. After much discussion Sinclair decides to borrow $30 million that it will use to repurchase shares. Sinclair’s Chief Executive Officer (CEO) has compiled the following information regarding the repurchase of the firm’s common stock:

• Share price at the time of buyback = $50
• Shares outstanding before buyback = 30,600,000
• EPS before buyback = $3.33
• Earnings yield = $3.33 / $50 = 6.7%
• After-tax cost of borrowing = 8.0%
• Planned buyback = 600,000 shares

Based on the information above, Sinclair’s earnings per share (EPS) after the repurchase of its common stock will be closest to:

A) $3.18.

B) $3.32.

C) $3.23.

---

Total earnings = $3.33 × 30,600,000 = $101,898,000

Since the 8.0% after-tax cost of borrowing is greater than the 6.7% earnings yield (E/P) of the shares, the share repurchase reduces Sinclair’s EPS.

karoliukas

Francis Investment Inc’s Board of Directors is considering repurchasing $30,000,000 worth of common stock. Francis assumes that the stock can be repurchased at the market price of $50 per share. After much discussion Francis decides to borrow $30 million that it will use to repurchase shares. Francis’ Chief Financial Officer (CFO) has compiled the following information regarding the repurchase of the firm’s common stock:

• Share price at the time of buyback = $50
• Shares outstanding before buyback = 30,600,000
• EPS before buyback = $3.33
• Earnings yield = $3.33 / $50 = 6.7%
• After-tax cost of borrowing = 4%
• Planned buyback = 600,000 shares

Based on the information above, after the repurchase of its common stock, Francis’ EPS will be closest to:

A) $3.36.

B) $3.41.

C) $3.39.

---

Total earnings = $3.33 × 30,600,000 = $101,898,000


Since the after-tax cost of borrowing of 4% is less than the 6.7% earnings yield (E/P) of the shares, the share repurchase will increase Francis’s EPS.

karoliukas

Pants R Us Inc.’s Board of Directors is considering repurchasing $30,000,000 worth of common stock. Pants R Us assumes that the stock can be repurchased at the market price of $50 per share. After much discussion Pants R Us decides to borrow $30 million that it will use to repurchase shares. Pants R Us’ Chief Investment Officer (CIO) has compiled the following information regarding the repurchase of the firm’s common stock:

• Share price at the time of buyback = $50
• Shares outstanding before buyback = 30,600,000
• EPS before buyback = $3.33
• Earnings yield = $3.33 / $50 = 6.7%
• After-tax cost of borrowing = 6.7%
• Planned buyback = 600,000 shares

Based on the information above, what will be Pants R Us’ earnings per share (EPS) after the repurchase of its common stock?

A) $3.28.

B) $3.40.

C) $3.33.

---

Total earnings = $3.33 × 30,600,000 = $101,898,000

Since the after-tax cost of borrowing of 6.7%% is equal to the 6.7% earnings yield (E/P) of the shares, the share repurchase has no effect on Pants R Us’ EPS.