Reference no: EM132842670

1. Imagine that Telephonic Industries has excess cash of $300,000 and is considering an immediate payment of this amount as an extra dividend. The firm forecasts that, after the dividend, earnings will be $450,000 per year. There are 100,000 shares outstanding. The cost of capital of the firm is 16.67%.

a) What is the price per share before and after ex-dividend date?

b) Consider an investor who owns 1000 shares of Telephonic's stock. What is the value and composition of her portfolio after the dividend is paid? To describe the composition of the portfolio, specify the value in cash and the value of the stock. Alternatively, the firm could use the excess cash to repurchase some of its own stock. For the following questions, imagine that the firm offers to buy existing stock at $30.

c) How many shares will the firm be able to buy? What will be the market value of equity after the repurchase? What will be the stock price after the repurchase? Consider the portfolio of investor X who owns 1000 shares. He didn't need any cash, at that time so he didn't sell any of the stock during the buy back.

d) What is the value and composition of her portfolio before the repurchase? What is the value and composition of her portfolio after the repurchase?

e) Suppose Investor X realizes that he actually needs cash $3000 in cash, but he missed up on the buy back. In general, he thinks it is unfortunate that the company decided to do a stock buyback instead of distributing a dividend. If you were her financial advisor, could you recommend one specific transaction she could do to replicate the portfolio composition had a $3 dollar dividend been paid? Specifically: how many shares would she need to buy or sell? At what price? What will be the value of her cash holdings after the transaction? What would be the value of her stock holdings after the transaction?