Chapter 18, Problem 21P

a.

Summary Introduction

To calculate: The current stock price of Carlton Corporation.

Introduction:

Stock price:

A stock price refers to the current price of a share of a company at which the stock is trading on. This price is determined on the basis of the supply and demand factors in the stock market.

Answer to Problem 21P

The current stock price is $50.

Explanation of Solution

The current stock price is computed as follows:

$\begin{array}{c}\text{Price per Share}=\text{P/E Ratio}\times \left(\frac{\text{Total Earnings}}{\text{Total Outstanding Shares }}\right)\\ =20\times \left(\frac{\$5\text{ million}}{2\text{ million } } \right) \\ =20\times \$2.50\\ =\$50\end{array}$

b.

Summary Introduction

To calculate: The dividend per share if $4 million is used to pay the dividends.

Introduction:

Dividend:

The dividend is the sum of money which is paid regularly to the shareholders as a return on their investments in the company.

Answer to Problem 21P

If $4 million is used to pay the dividends, then the dividend per share is $2.

Explanation of Solution

The dividend per share can be calculated as follows, if $4 million is used to pay the dividend by the company:

$\begin{array}{c}\text{Dividend per Share}=\frac{\text{Dividend Paid }}{\text{Number of Outstanding Shares}} \\ =\frac{\$4\text{ million } }{2\text{ million} }\\ =\$2\text{ per share}\end{array}$

c.

Summary Introduction

To calculate: The number of shares acquired if $4 million is used to repurchase shares in the market at a price of $54 per share.

Introduction:

Stock price:

A stock price refers to the current price of a share of a company at which the stock is trading on. This price is determined on the basis of the supply and demand factors in the stock market.

Answer to Problem 21P

If $4 million is used to repurchase shares in the market at a price of $54 per share, then the number of shares acquired is 74,074.

Explanation of Solution

The number of acquired shares can be calculated, if an excess amount of $4 million is used for repurchasing shares at $54 per share.

$\begin{array}{c}\text{Number of Acquired Shares for Repurchasing}=\frac{\text{Excess Amount Available }}{\text{Repurchase share price}}\\ =\frac{\$4,000,000}{\$54}\\ =74,047\text{ shares}\end{array}$

d.

Summary Introduction

To calculate: New earnings per share.

Introduction:

Earnings per share (EPS):

It is the profit per outstanding share of a public company. A higher EPS indicates higher value of the company because investors are ready to pay higher price for one share of the company. 

Answer to Problem 21P

New EPS is $2.60.

Explanation of Solution

The new EPS can be calculated as follows:

$\begin{array}{c}\text{EPS}=\frac{\text{Total Earnings}}{\left(\text{Share Outstanding}-\text{Number of Acquired Shares after Repurchasing}\right)}\\ =\frac{\$5,000,000}{\left(2,000,000-74,047\right)}\\ =\frac{\$5,000,000}{1,925,926}\\ =\$\mathrm{2.60.}\end{array}$

e.

Summary Introduction

To calculate: The price of security, if P/E ratio remains constant and the stock price increases.

Introduction:

P/E ratio:

This is the ratio of a corporation’s share price to its EPS. This ratio is used to determine if the company is undervalued or overvalued.

Answer to Problem 21P

The price of share is $52 and increase in the stock is $2.

Explanation of Solution

The calculation of the price of the shares is as follows:

$\begin{array}{c}\text{Price of Share}=\text{P/ E ratio}\times \text{EPS}\\ =20\times \$2.60\\ =\$52\end{array}$

The increase in the stock can be computed as follows:

$\begin{array}{c}\text{Increase in Stock}=\text{New Price of Stock}-\text{Old Price of Stock}\\ =\$52-\$50\\ =\$2.\end{array}$

f.

Summary Introduction

To calculate: The change in the wealth of the shareholders as a result of change in the stock price, as opposed to receiving the cash dividend.

Introduction:

Stock price:

A stock price refers to the current price of a share of a company at which the stock is trading on. This price is determined on the basis of the supply and demand factors in the stock market.

Answer to Problem 21P

The wealth of the shareholder has changed due to the increased total value per share by $52.

Explanation of Solution

The calculation of the total value per share is as follows:

$\begin{array}{c}\text{Total Value per Share}=\text{Market Value per Share}+\text{Cash Dividend per Share}\\ =\$50+\$2\\ =\$52\end{array}$

By repurchasing the stock, the total value per share is increased to $52, so the wealth of the shareholders has increased.

g.

Summary Introduction

To explain: The reasons of repurchase of shares by a corporation.

Introduction:

Repurchase of shares:

The repurchase of share is a transactional process in which a company repurchases its shares from the marketplace, due to the management’s consideration of being its shares being undervalued.

Answer to Problem 21P

The reason for the repurchase of shares is considered by the company as being undervalued or underpriced. And, also the repurchase of share can be for the stock option plan for the employees of the company. 

Explanation of Solution

The reason for repurchase is that the appreciation in value associated with a stock repurchase defers the capital gains tax until the stock is sold, whereas dividends are taxed when received.

Another reason for the repurchase of shares is that the company considers its shares to be undervalued or underpriced, so repurchase will bring down the supply of shares and will increase the price of the share.

The company also repurchases its share to be used under the employee stock option plan and as a protective device.