# Fin 8091

**Topics:**Net present value, Corporate finance, Investment

**Pages:**16 (3767 words)

**Published:**February 4, 2015

1. Hole Foods Donuts, Ltd. has generated profits of $2 per share for many years and has consistently paid 100% of those profits to shareholders via a dividend. Investors do not expect Hole Foods Donuts to grow in the future. The company has 200,000 shares of stock outstanding worth $20 per share. Suppose the firm decides to eliminate its dividend and instead use the money to repurchase shares.

A. Assuming that there are no taxes and that the repurchase announcement conveys no new information to investors about the profitability or risk of Hole Foods Donuts, how do you think the stock price will react to announcement? Provide a written (in words) explanation or a numerical example to provide support for your answer.

If there are no taxes the profit may increase

As the repurchase announcement conveys no new information to investors about the profitability or risk it will be a good idea as the investors do not expect Hole Foods Donuts to grow in future But with no tax and repurchase of share will increase the share value and investors will assuming that company is earning more profit and growing in speed.

B. How many shares will Hole Foods Donuts repurchase?

Total Number of Shares: - 200,000 Share Price: - $ 2/ share Total Share Price: - Total Number of Share X Per Share Price = Total Share Price 200,000 X 2 = $ 400,000 Therefore,

No. Share Repurchase: - Total share Price ÷ Outstanding Share price = No. of Share can Buy 400,000 ÷ 20 = 20,000 Shares

C. If the signalling argument for repurchases is valid, what stock price would you expect for Hole Foods Donuts one and two years after this announcement? What would the stock price have been in the next two years if the company had simply maintained its old dividend policy?

First year

Equity value: - Total Number of Share X Outstanding Share price = Equity value 200,000 X 20 = $ 400,000

Outstanding Share: - Total Number of Share - No. Share Repurchase 200,000 - 20,000 = 180,000 Shares

Value of Share: - Equity value ÷ Outstanding Share = Value of Share 400,000 ÷ 180,000 = $22.22

Second Year

Equity value: - Total Number of Share X Outstanding Share price = Equity value 180,000 X 22.22 = $ 3,999,600

Outstanding Share: - Total Number of Share - No. Share Repurchase = Share 180,000 - 18,000 = 162,000 Shares

Value of Share: - Equity value ÷ Outstanding Share = Value of Share 3,999,600 ÷ 162,000 = $24.71

2. Justso Ltd buys on terms 1.5/10, net 30 days. It does not take discounts, but it typically pays 20 days after the invoice date, instead of waiting until Day 30. Justso can borrow from the bank at a rate of 18% per annum.

A. If Justso is not taking discounts and is paying on Day 20, what is the effective annual cost of the firm’s current practice, using a 360-day year? Discount:- 1.5, Credit Period:- 30, Discount Period:- 10

Cash Discount Formula= Discount X 360

100 – Discount 15 X 360 100 – 1.5...

References: Book

Compute the NPV, IRR, and Payback Period Accounting Rate of Return [Kindle Edition]

HomeworkHelp classof1 (Author)

Links

http://accountingexplained.com/managerial/capital-budgeting/irr

http://www.calkoo.com/?lang=3&page=26

http://www.investopedia.com/terms/p/paybackperiod.asp

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