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Fundamentals of Financial Manageme...

9th Edition
Eugene F. Brigham + 1 other
ISBN: 9781305635937

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Fundamentals of Financial Manageme...

9th Edition
Eugene F. Brigham + 1 other
ISBN: 9781305635937
Textbook Problem
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STOCK REPURCHASES Gamma Industries has net income of $3,800,000, and it has 1,490,000 shares of common stock outstanding. The company’s stock currently trades at $67 a share. Gamma is considering a plan in which it will use available cash to repurchase 10% of its shares in the open market at the current $67 stock price. The repurchase is expected to have no effect on net income or the company’s P/E ratio. What will be its stock price following the stock repurchase?

Summary Introduction

To calculate: Company G’s stock price following the stock repurchase.

Introduction:

Share Repurchase: When a company issues its shares in the open market and finds that the share issued by the company are undervalued, the management decides to buy back its own shares to decrease the number of shares outstanding.

Explanation

Calculate number of stock repurchased.

Given,

Number of outstanding shares are 1,490,000.

Percentage of repurchase of shares is 10%.

Formula to calculate number of stock repurchased,

Numberofstockrepurchase=Outstandingshares×%ofrepurchaseofshares

Substitute 1,490,000 for outstanding shares and 10% for repurchase of shares.

Numberofstockrepurchase=1,490,000×10%=149,000

So, total number of shares repurchase is 149,000.

Calculate repurchase amount at current price of $67.

Number of repurchased shares is 149,000 (calculated above).

Current stock price is $67 (given).

Formula to calculate repurchase amount at current price,

Repurchaseamount=Numberofrepurchaseshares×currentstockprice

Substitute 149,000 for repurchase shares and $67 for current stock price.

Repurchaseamount=149,000×$67=$9,983,000

So repurchase amount of shares is $9,983,000.

Calculate old Earning per Share.

Given,

Number of outstanding shares is 1,490,000.

Net income is $3,800,000.

Formula to calculate old EPS,

EPSOld=NetincomeNumberofsharesoutstanding

Substitute $3,800,000 for net income, and 1,490,000 for outstanding shares.

EPSOld=$3,800,0001,490,000=$2.55

So,old EPS is $2.55.

Calculate old P/E (price-earning) ratio.

Current stock price is $67 (given).

Old EPS is $2.55 (calculated above).

Formula to calculate old P/E ratio,

P/EOld=CurrentstockpriceEPSOld

Substitute $2

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