Ellinger Inc. is a mature company in a mature industry. It plans to distribute all of its income at year-end, and its earnings are not expected to grow. The CFO is now considering whether the firm should distribute income to stockholders as dividends or use the funds to repurchase common stock. She believes the P/E ratio would not be affected by a repurchase. Moreover, she believes that the stock can be repurchased at the end of the year at the then-current price, which is expected to be the now-current price plus the dividend that would otherwise be received at year-end. Based on the data shown below, and disregarding any possible tax effects, how much would a stockholder who owns 100 shares gain if the firm used its net income to repurchase stock rather than for dividends?

Question

Quizplus · Accepted Answer

If the firm uses its net income to repurchase stock, the stockholder would gain the equivalent of the dividend amount per share multiplied by the number of shares they own. Since the P/E ratio remains unchanged and the stock price increases by the dividend amount, the gain is the dividend amount per share, which is $6.25, multiplied by 100 shares, resulting in a gain of $625.00.