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Cash Dividends vs Stock Repurchase

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Lyle Communications had finally arrived at the point where it had sufficient excess cash flow of \$2.4 million to consider paying a dividend. It had 2 million shares outstanding and was considering paying a cash dividend of \$1.20 per share. The firm's total earnings were \$8 million providing \$4.00 in earnings per share. Lyle Communications stock traded in the market at \$64.00 per share.

However, Liz Crocker, the chief financial officer, was not sure paying the cash dividend was the best route to go. She had recently read a number of articles in The Wall Street Journal about the advantages of stock repurchases and before she made a recommendation to the CEO and board of directors, she decided to do a number of calculations.

a.   What is the firm's P/E ratio?

b.   If the firm paid the cash dividend, what would be the firm's dividend yield and dividend payout ratio per share?

c.   If a stockholder held 100 shares of stock and received the cash dividend, what would be the total value of his portfolio?

d.   Assume instead of paying the cash dividend, the firm used the \$2.4 million of excess funds to purchase shares at slightly over the current market value of \$64 at a price of \$65.20. How many shares could be repurchased?

e.   What would the new earnings per share be under the stock repurchase alternative?

f.    If the P/E ratio stayed the same under the stock repurchase alternative, what would be the stock value per share? If a stockholder owned 100 shares, what would now be the total value of his portfolio?

Solution Preview

a. What is the firm's P/E ratio?

P/E ratio is the Market Price divided by the earnings per share (EPS). The market price is 64 and the EPS is 4. The P/E = 64/4 = 16

b. If the firm paid the cash dividend, what would be the firm's dividend yield and dividend payout ratio per share?

The dividend yield is the dividend per share divided by the market price. The dividend per share is 1.20 and the market price is 64. The dividend ...

Solution Summary

The solution explains the effect on the value of stock of a cash dividend or a stock repurchase. It uses simple calculations and explanations to arrive at the answer.

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