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Suppose a company's current earnings are $400 million, that it has 40 million shares of stock, and that it pays out 60% of its earnings as dividends. Earnings are expected to grow at a constant rate of 5%, and the cost of equity is 10%. The firm had to make a decision as to whether they should pay dividend or use the money to repurchase shares. The Company wants to calculate the market value of the company in case of paying dividend or repurchase to make that decision.
a) What will be the market value of the equity in case dividends are paid in Year 1?
b) What will be the market value of the equity in case share repurchase is done in Year 1?
Note: The amount of funds for share repurchases is assumed to be the same amount as the dividend payment from question
a). The average price per share would be the same as determined in question a).
c) Discuss the pros and cons of share repurchases vs. cash dividends in the light of tax-advantage, restructuring and signaling effect
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