Question 5 (Total Marks: 10)

Sarah is a shareholder in Twilight Corporation. The current price of Twilights stock is $55 per share, and there are 1 million shares outstanding. Sarah owns 40,000 shares, or 4% of the stock, which she purchased one year ago for $50 per share.

Twilight Corporation makes a surprise announcement that it plans to repurchase 200,000 shares of its own stock at a price of $60 per share. In response to this announcement, Twilights stock price increases $3 per share, from $55 to $58, but this price is expected to fall back to $56 per share after the repurchase is completed. Assume that Sarah faces marginal personal tax rates of 35% on dividend income and capital gains tax rate of 15%.

Answer the following questions:

a. In terms of payout policy, briefly explain the main differences between dividends and share repurchases. (Marks: 2)

b. Given the tax rates that Sarah faces which form of payout is more beneficial from her perspective? (Marks: 2)

c. Calculate Sarahs (realized) after-tax return in dollar terms and percentage terms from her investment in Twilight shares, if she chooses to participate in the repurchase program and all her shares tendered are purchased at $60 per share. (Marks: 2)

d. How many shares will Sarah be able to sell if all Twilight shareholders tender their shares to the firm as part of this repurchase program and the company purchases shares on a pro rata basis? (Marks: 2)

e. What fraction of Twilights total common equity will Sarah own after the repurchase program is completed if she chooses not to tender her shares? (Marks: 2)

Please show all your calculations clearly.