Good
Values, Inc., is allequityfinanced. 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 aftertax 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 beforetax rate of return for a 1year holding period. (Do not round intermediate calculations. Round your answers
to 2 decimal places.)

Beforetax rate of
return

%

c.

Now
suppose that the dividend will be $2 per share. If the expected aftertax
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

$

d1.

What
is the beforetax rate of return? (Do not round
intermediate calculations. Round your answer to 2 decimal places.)

Beforetax rate of
return

%

d2.

Why is it now higher than in part
(b)?

The beforetax 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 (aftertax dividend plus final share price) =

[$1 × (1 − 0.30)] + $10

= $9.73

1.10

b.
Beforetax
rate of return =

dividend + capital gain

=

$1.00 + ($10.00 − $9.73)

= 0.1308 = 13.08%

price

$9.73

c.
Price
= PV (aftertax dividend plus final share price) =

[$2 × (1 − 0.30)] + $10

= $10.36

1.10

d1.
Beforetax
rate of return =

dividend + capital gain

=

$2 + ($10 − $10.36)

= 0.1579 = 15.79%

price

$10.36

d2.
The
beforetax return must increase in order to provide the same aftertax return
of 10%.
