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Dividend policy

Example 2

McGreggor Co has 10,000 share in issue, trading at $50 per share. The Board
is considering returning cash of $50,000 to shareholders either as a cash
dividend or as a share repurchase.

Required:

Calculate the wealth of a shareholder who currently owns 100 shares in
each case.

Solution

Cash dividend

Dividend per share = ($50,000/10,000 shares) = $5

Therefore, ex-dividend share price = $50 – $5 = $45

So the shareholder who owns 100 shares will have wealth of:

Dividend received + Share value = (100 × $5) + (100 × $45) = $5,000

Share repurchase

Number of shares repurchased in total will be ($50,000/$50) = 1,000

i.e. 10% of the total 10,000 shares.

Therefore there will now be (10,000 – 1,000 =) 9,000 shares in issue, with a
value of

[(10,000 × $50) – $50,000]/[10,000 – 1,000] = $50 each

So the shareholder who owned 100 shares before the repurchase will now
have wealth of:

Cash received in share repurchase + Share value = (10 × $50) + (90 × $50) =
$5,000.

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