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. What will be the market price per share of Alex's stock after the repurchase?

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. What will be the market price per share of Alex's stock after the repurchase?

Assume the firm uses the $25,000 excess cash to buy back stock at $5 per share. What will be the market price per share of Alex's stock after the repurchase?

Quizplus · Accepted Answer

The market price per share will remain at $5.00 because the repurchase does not change the value of the firm per share. The firm uses $25,000 to buy back 5,000 shares, reducing the number of shares to 95,000, but the market value of equity remains the same at $475,000, keeping the price per share at $5.00.

Alex, Inc Is Financed 100% with Equity