Question

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?

Answer 1

Answer:

stock price following the stock repurchase = $74.44

Explanation:

Stock Repurchases Gamma Industries has net income of $3,800,000, and it has 1,490,000 shares of common stock outstanding.

Formula for earnings per share:

Earnings per share = Net income/ number of shares outstanding

As Number of shares outstanding before repurchase = 1490000

Net Income = $3800000

Therefore by putting the values in the above formula, we get

Earnings per Share = $3,800,000/1,490,000

Earnings per Share = $2.5503  

Formula for Price Earnings Ratio:

Price Earnings Ratio = Price / Earnings per share

Therefore by putting the values in the above formula, we get

Price Earnings Ratio = $67 / $2.5503

Price Earnings Ratio = $26.2710

As the company wants to repurchase 10% of its existing outstanding shares so

Number of shares repurchase = 1,490,000 × 0.10 = 149,000

 

The remaining number of outstanding shares are = 1,490,000 -149,000 = 1,341,000

Formula for Earnings per Share:

Earnings per Share = Net Income / number of shares outstanding

Therefore, its Earnings per Share after repurchase = $3,800,000 / 1,341,000 = $2.8337

As Price/ Earnings = 26.27 so the stock price following the stock repurchase  = 26.2710 × 2.8337 = $74.44