The stock market is generally depressed, and the price of Westin Metals Inc.’s common shares has been below its historic average value for some time. The shares are trading at $35 which represents a P/E of 19 on earnings of $7,000,000. Before the current slump, Westin generally maintained a P/E of at least 24.
Despite the general downturn, the firm is doing well, and the CFO is considering an equity repurchase to enhance the position of stockholders who retain their shares when the market recovers. She has identified a piece of real estate the company owns but isn’t using, which was purchased 20 years ago for $2,000,000 and can be sold for $9,000,000 today. Using the proceeds of such a sale would make it possible to do the repurchase without impacting dividends or the capital budget. The CFO has asked you to quantify the effect of her plan on stock price, and make a recommendation as to whether she should present it to the Board of Directors. Assume it takes two years for the market to recover and that Westin’s P/E returns to 24 at that time. Also assume earnings grow at 5% per year until then and the company’s marginal tax rate is 37%. Round any number of shares calculations to the nearest 1,000 shares.