Alex, Inc. is financed 100% with equity. The firm has 100,000 shares of stock outstanding with a market price of $5 per share. Total earnings for the most recent year are $50,000. The firm has cash of $25,000 in excess of what is necessary to fund its positive NPV projects. The firm is considering using the cash to pay an extra dividend of $25,000 or, alternatively, to repurchase $25,000 of stock. The firm has other assets worth $475,000 (market value). For each of the questions that follow, assume there are no transaction costs, taxes, or other market imperfections.

Assume the firm uses the $25,000 excess cash to buy back stock at $5 per share. You own 1,000 shares before the repurchase and this comprises your total wealth. If you sold none of your shares back to the firm, what is your total wealth after the repurchase is completed?

Question

Alex, Inc. is financed 100% with equity. The firm has 100,000 shares of stock outstanding with a market price of $5 per share. Total earnings for the most recent year are $50,000. The firm has cash of $25,000 in excess of what is necessary to fund its positive NPV projects. The firm is considering using the cash to pay an extra dividend of $25,000 or, alternatively, to repurchase $25,000 of stock. The firm has other assets worth $475,000 (market value) . For each of the questions that follow, assume there are no transaction costs, taxes, or other market imperfections.

Assume the firm uses the $25,000 excess cash to buy back stock at $5 per share. You own 1,000 shares before the repurchase and this comprises your total wealth. If you sold none of your shares back to the firm, what is your total wealth after the repurchase is completed?

Assume the firm uses the $25,000 excess cash to buy back stock at $5 per share. You own 1,000 shares before the repurchase and this comprises your total wealth. If you sold none of your shares back to the firm, what is your total wealth after the repurchase is completed?

Quizplus · Accepted Answer

After the repurchase, the firm uses $25,000 to buy back 5,000 shares, leaving 95,000 shares outstanding. The firm's value remains $500,000 ($475,000 in assets + $25,000 cash before repurchase). Your wealth remains $5,000 (1,000 shares x $5/share).

Alex, Inc Is Financed 100% with Equity