Ramirez Supplies believes that at its current stock price of $16.00 the firm is undervalued in the market. Ramirez plans to repurchase 2.4 million of its 20 million shares outstanding. The firm's managers expect that they can repurchase the entire 2.4 million shares at the expected equilibrium price after repurchase. The firm's current earnings are $44 million. If management's assumptions hold, what is the expected per-share market price after repurchase? Assume that the firm's P/E ratio is not affected by the recapitalization.

Question

Quizplus · Accepted Answer

The expected per-share market price after repurchase can be calculated as follows: First, find the earnings per share (EPS) before the repurchase, which is $44 million / 20 million shares = $2.20. After repurchasing 2.4 million shares, the company will have 17.6 million shares outstanding. Assuming the P/E ratio remains constant, the value of the firm should remain the same, so the new EPS will be $44 million / 17.6 million shares = $2.50. Since the P/E ratio is constant and the EPS after repurchase is $2.50, the expected per-share market price after repurchase can be calculated by multiplying the new EPS by the P/E ratio. Given that the initial stock price was $16 and the initial EPS was $2.20, the P/E ratio is $16 / $2.20 = 7.27. Therefore, the expected per-share market price after repurchase is $2.50 * 7.27 = $18.18.

Ramirez Supplies Believes That at Its Current Stock Price of $16.00