The XYZ Corporation has an expected dividend of

$4 one period from now. This dividend is expected to grow by 2 percent per period.

a. What is the value of a share of stock, assuming that the appropriate discount rate for expected future dividends—e.g., the expected rate of appreciation in the share price of XYZ between dividends—is 10 percent per period? For your answer, assume that the effective personal tax rate on dividends is 40 percent and the effective personal tax rate on capital gains and share repurchases is zero.

b. The XYZ Corporation announces that it will stop paying dividends. Instead, the company will engage in a stock repurchase plan under which future cash that would previously have been earmarked for dividend payments will now be used exclusively for stock repurchases.

Assuming no information effects, what should the new price of a share of XYZ stock be when market participants first learn of this announcement?

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