A company has 500 million shares outstanding at 90c per share. (a) Calculate the companys market capitalization

Question:

A company has 500 million shares outstanding at 90c per share.

(a) Calculate the company’s market capitalization (the value of its equity).

(b) Suddenly, the company announces an unexpected €50 million one-off increase in the year’s after-tax earnings. What should be the effect of the announcement on the market capitalization and on the share price?

(c) The company pays the entire 50 million as a special dividend. What will be the ex-dividend value of the equity and the ex-dividend share price?

(d) Suppose that, instead of paying the special dividend, the company buys back €50 million worth of the company’s shares from the shareholders. How many shares does this leave outstanding? What would be the resulting market capitalization?
How will the resulting share price compare with the alternative of paying the dividend?

(e) The company is subject to a classical tax system. All the company’s shareholders pay taxes at the 40% rate on dividends and at the 20% rate on capital gains. How much better or worse off are the shareholders if the company buys back the shares rather than paying the special dividend?

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