Acme Explosives Inc.is an international producer of creative demolition products.Acme is all equity financed.Acme has too much cash,which it wants to distribute to its shareholders.Selected financial information for Acme is provided in the table.David Wylie is a director at Acme.Next Friday the board is meeting to vote on the format of the distribution.There are three choices on the ballot: 1)an extra dividend of $4 per share; 2)a stock dividend of 0.5 shares for each existing share; or 3)an open market stock repurchase to buy 28.5% of shares outstanding at a price of $14.04.As part of his compensation package,David has options to purchase one million shares at a price of $12 per share.If David's sole concern is his own wealth,then how should he vote at the board meeting?
Selected Financial Information
For Acme Corporation

Question

Quizplus · Accepted Answer

The extra dividend will reduce the stock price by the amount of the dividend to a level of $10.04. This will make his stock options much less valuable. He would move from a position where he would be willing to exercise the options to a position where he would not.
Because the repurchase would be executed at the same price as prevails beforehand, the repurchase would not affect the stock price and would not reduce the value of David's stock options. He would still want to exercise the options.
The stock dividend would not distribute the cash, but it would reduce the share price and so reduce the value of David's stock options.