Task: Dividends versus Repurchases.
Big Industries has the following market-value balance sheet. The stock currently sells for $20 a share, and there are 1,000 shares Outstanding. The firm will either pay a $1 per share dividend or repurchase $1,000 worth of stock. Ignore taxes.
Assets Liabilities and Equity
Cash $ 2,000 Debt $ 10,000
Fixed assets 28,000 Equity 20,000
Q1. What will be the price per share under each alternative (dividend versus repurchase)?
Q2. If total earnings of the firm are $2,000 a year, find earnings per share under each alternative.
Q3. Find the price-earnings ratio under each alternative.
Q4. Adherents of the "dividends-are-good" school sometimes point to the fact that stocks with high dividend payout ratios tend to sell at above-average price-earnings multiples.
Is this evidence convincing? Discuss this argument with regard to your answers to parts (1)-(3).