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Monday, 9 July 2012

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%.

The stock of Payout Corp. will go ex-dividend tomorrow. The dividend will be $0.90 per share,


The stock of Payout Corp. will go ex-dividend tomorrow. The dividend will be $0.90 per share, and there are 21,000 shares of stock outstanding. The market-value balance sheet for Payout is shown on the following table. Ignore taxes.



  Assets
  Liabilities and Equity
  Cash
$
230,000  
  Equity
$1,260,000  
  Fixed assets

1,030,000  





a.
What price is Payout stock selling for today?

  Price
$  

b.
What price will it sell for tomorrow? (Round your answer to 2 decimal places.) 

  Price
$  


Explanation:
a.
P = $1,260,000/21,000 = $60

b.
The price tomorrow will be $0.90 per share lower, or $59.10.

Shares in Raven Products are selling for $50 per share. There are 1 million shares outstanding.


Shares in Raven Products are selling for $50 per share. There are 1 million shares outstanding. What will be the share price in each of the following situations? Ignore taxes. (Do not round intermediate calculations.)



    Share Price
a.
The stock splits five for four.
$   
b.
The company pays a 25% stock dividend.
  
c.
The company repurchases 100,000 shares.
  




Explanation:
a. The stock price will fall to $50 × 4/5 = $40.
b. The stock price will fall by a factor of 1.25 to $50/1.25 = $40.
c. A share repurchase will have no effect on price per share.