Answer:
Stock Repurchase is refers to the mechanism through which company buy backs its own shares. When the shares are repurchased the number of shares that an investor holds reduces and his cash balance increases by the amount of purchase.
Part a.
PC is regularly paying a quarterly dividend of $0.50 per share. If the company instead of paying dividend announces the buyback of $10,000 market value stock.
Compute the effect on the wealth of the shareholder who holds 100 shares and sells 1 of the shares in the following manner:
Market value of shares =100 × $50
Market value of shares = 55,000
Before repurchasing, the total value of the shares for the investor is $5,000
After repurchasing, for 1 share repurchased, the company will pay him $50.
Compute the value of the remaining shares in the following manner.
Market value of remaining shares = Remaining shares x Price after repurchase
Substitute $50 for price after repurchasing and 100 - 1 = 99 for remaining number of shares.
Market value of remaining shares = Remaining shares × Price after repurchase
Market value of remaining shares = 99 × $50
Market value of remaining shares = $4950
The total wealth of the shareholder after the repurchase is $4,950 + $50 =$5,000
Part b.
There would be no effect because the share price would remain at $50 irrespective of whether the company repurchases the shares or offers dividend.
The only difference is that the total market capitalization of the company would be reduced to $990,000 (19,800 shares at 50 per share) in case of repurchase as against the market capitalization of $1,000,000 (20,000 shares at 50 per share) in case of issuing dividend.
However, this is not important since the market price per share remains the same.
