Good Values, Inc., is all-equity-financed. The total market value of the firm currently is

Good Values, Inc., is all-equity-financed. The total market value of the firm currently is $240,000, and there are 3,000 shares outstanding. Good Values plans to repurchase $24,000 worth of stock. Ignore taxes.

a.	What will be the stock price before and after the repurchase?

	Stock Price
Before	$ per share
After	per share

Explanation:

a.

The repurchase will have no tax implications. Because the repurchase does not create a tax obligation for the shareholders, the value of the firm today is the value of the firm’s assets ($240,000) divided by 3,000 shares, or $80 per share. The firm will repurchase 300 shares for $24,000. After the repurchase, the stock will sell at a price of $216,000/2,700 = $80 per share.

The price is the same as before the repurchase.

Investors require an after-tax rate of return of 10% on their stock investments. Assume that the tax rate on dividends is 30% while capital gains escape taxation. A firm will pay a $1 per share dividend 1 year from now, after which it is expected to sell at a price of $10.

a.	Find the current price of the stock. (Do not round intermediate calculations. Round your answer to 2 decimal places.)

Current price

$

b.	Find the expected before-tax rate of return for a 1-year holding period. (Do not round intermediate calculations. Round your answers to 2 decimal places.)

Before-tax rate of return

%

c.	Now suppose that the dividend will be $2 per share. If the expected after-tax rate of return is still 10%, and investors still expect the stock to sell at $10 in 1 year, at what price must the stock now sell? (Do not round intermediate calculations. Round your answer to 2 decimal places.)

Price

$

d-1.	What is the before-tax rate of return? (Do not round intermediate calculations. Round your answer to 2 decimal places.)

Before-tax rate of return

%

d-2.	Why is it now higher than in part (b)?

The before-tax return is higher because the larger dividend creates a   greater tax burden.

Explanation:

Some values below may show as rounded for display purposes, though unrounded numbers should be used for the actual calculations.

a. 

Price = PV (after-tax dividend plus final share price) =	[$1 × (1 − 0.30)] + $10	= $9.73
	1.10

b.

Before-tax rate of return =	dividend + capital gain	=	$1.00 + ($10.00 − $9.73)	= 0.1308 = 13.08%
	price		$9.73

c. 

Price = PV (after-tax dividend plus final share price) =	[$2 × (1 − 0.30)] + $10	= $10.36
	1.10

d-1.

Before-tax rate of return =	dividend + capital gain	=	$2 + ($10 − $10.36)	= 0.1579 = 15.79%
	price		$10.36

d-2.

The before-tax return must increase in order to provide the same after-tax return of 10%.