Modern Furniture Company had finally arrived at the point where it had a sufficient excess cash flow of $4.8 million to consider paying a dividend. It had 3 million shares of stock outstanding and was considering paying a cash dividend of $1.60 per share. The firm's total earnings were $12 million, providing $4.00 in earnings per share. The stock traded in the market at $88.00 per share.
However, Al Rosen, the chief financial officer, was not sure that paying a cash dividend was the best route to go. He had recently read a number of articles in The Wall Street Journal about the advantages of stock repurchases and before he made a recommendation to the CEO and board of directors, he decided to do a number of calculations.
- What is the firm's P/E ratio?
- If the firm paid the cash dividend, what would be its dividend yield and dividend payout ratio per share?
- If a stockholder held 100 shares of stock and received the cash dividend, what would be the total value of his portfolio (stock plus dividends)?
- Assume instead of paying the cash dividend, the firm used the $4.8 million of excess funds to purchase shares at slightly over the current market value of $88 at a price of $89.60. How many shares could be repurchased? (Round to the nearest share.)
- What would the new earnings per share be under the stock repurchase alternative? (Round to three places to the right of the decimal point.)
- 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? (This answer should be approximately the same as the answer to part c.)