Market Value of Stock
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XYZ Corporation has earnings of $750,000 with 300,000 shares outstanding. Its P/E ratio is 16. The firm is holding $400,000 of funds to invest or pay out in dividends. If the funds are retained, the after-tax return on investment will be 15 percent, and this will add to present earnings. The 15 percent is the normal return anticipated for the corporation and the P/E ratio would remain unchanged. If the funds are paid out in the form of dividends, the P/E ratio will increase by 10 percent because the stockholders are in a very low tax bracket and have a preference for dividends over retained earnings. Which plan will maximize the market value of the stock?
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Solution Summary
The solution explains how to evaluate the plans by calculating the impact on the market value of stock.
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The current EPS = 750,000/300,000=2.50 and the stock price is 2.50X16=$40 ( EPS X P/E)
We find the stock price under the two ...
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