You own 1 million shares in Locos Inc a 100% equity company that your purchased paying $10 per share. Last week the company was worth $100 million with 10 million shares outstanding. Yesterday the management announced a merge that increased the company value by $25 million, which will be reflected in the stock price today. The company is trying to decide whether to issue a dividend or repurchase shares at the current market price to distribute the $25 million increase in valuation. Your marginal tax rate on dividends is 25% and 15% on capital gains. In this question you need to determine what is more beneficial for you, dividends or repurchases.

a) What is your after tax wealth if the $25 million are paid as repurchase, assuming that you are able to sell ALL your shares at the repurchase price?

b) What is your after tax wealth if the $25 million are paid as dividend,? Assume that the stock market price will decrease exactly on the value of the dividend after the dividends are payed, and that you will sell all your shares after the dividend is paid at the market price.

c) Suppose now that you will keep the shares for 5 years after dividends are payed and then sell them, and you expect that the price of the stock increase by 10% per year. What is the present value of your wealth in this case? (Assume a 10% discount rate)

Answer rating: 100% (QA)

Lets calculate the aftertax wealth for each scenario a AfterTax Wealth with Share Repurchase If the 25 million increase in valuation is paid as a shar... View the full answer