The JRN Corporation will pay a constant dividend of $5 per share per year in perpetuity. Assume that all investors pay a 25% tax on dividends and that there is no capital gains tax. The cost of capital for investing in JRN stock is 10%. Assume that management makes a surprise announcement that JRN will no longer pay dividends but will use the cash to repurchase stock instead. The price of a share of JRN's stock is now closest to ________.

Question

Quizplus · Accepted Answer

B) In a perfect capital market the dividend or repurchase decision does not impact firm value. Since the tax rate for repurchases is zero, the stock price would be the same as if the firm paid out the dividend and the dividends were not taxed, so:
Price per share = Dividend / cost of capital = $5 / 10% = $50.00

The JRN Corporation Will Pay a Constant Dividend of $5