The Gallagher Company has $1 million in excess cash it wishes to return to stockholders. Selected financial information is as follows. $\begin{array}{lr}\text { Earnings after taxes} &\$2,500,000\
\text {Shares of stock outstanding }&1,000,000\
\text {Price-earrings ratio }&10\
\text {Market price of Gallagher's stock}&\$25\
\end{array}$
If Gallagher chooses to distribute the cash through a stock repurchase and the price earnings ratio doesn't change through the transaction, what will the stock's market price be after the shares are acquired?

Question

The Gallagher Company has $1 million in excess cash it wishes to return to stockholders. Selected financial information is as follows. $\begin{array}{lr}\text { Earnings after taxes} &\$2,500,000\
\text {Shares of stock outstanding }&1,000,000\
\text {Price-earrings ratio }&10\
\text {Market price of Gallagher's stock}&\$25\
\end{array}$
 If Gallagher chooses to distribute the cash through a stock repurchase and the price earnings ratio doesn't change through the transaction, what will the stock's market price be after the shares are acquired?

Quizplus · Accepted Answer

After the repurchase, the number of shares will decrease, increasing the earnings per share (EPS). The new EPS will be $2,500,000 / (1,000,000 - 40,000) = $2.604. With a constant P/E ratio of 10, the new stock price will be 10 * $2.604 = $26.04.

The Gallagher Company Has $1 Million in Excess Cash It