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

Quizplus · Accepted Answer

Your total wealth remains $5,000 because the repurchase does not affect your ownership percentage or the value of your shares. The firm uses its excess cash to buy back shares, reducing the number of shares outstanding, but your shares retain their value.

Alex, Inc Is ﬁNanced 100% with Equity