Question

Gamma Industries has net income of $1,600,000, and it has 1,830,000 shares of common stock outstanding. The company's stock currently trades at $75 a share. Gamma is considering a plan in which it will use available cash to repurchase 25% of its shares in the open market at the current $75 stock price. The repurchase is expected to have no effect on net income or the company's P/E ratio. What will be its stock price following the stock repurchase? Do not round intermediate calculations. Round your answer to the nearest cent.

Answer 1

Answer:

$99.99

Explanation:

Gamma Industries has net income of $1,600,000, and it has 1,830,000 shares of common stock outstanding.

Therefore,

its Earnings per Share = $1,600,000 ÷ 1,830,000

                                     = $0.8743

Now, its current stock price is $75

Therefore, the Price Earnings Ratio:

= $75 ÷ $0.8743

= 85.7829

Now, the company wants to repurchase 25% of its existing outstanding shares i.e.

= 1,830,000 × (25 ÷ 100)

= 457,500

The remaining number of outstanding shares:

= 1,830,000 - 457,500

= 1,372,500

Therefore,

its Earnings per Share after repurchase:

= $1,600,000 ÷ 1,372,500

= $1.1657

Therefore, the stock price following the stock repurchase

= Price Earnings Ratio × Earnings per Share after repurchase

= 85.7829 × $1.1657

= $99.99 (note that the price earning ratio remains unchanged)