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Overholser Inc has forecast net income of $8,000,000 over next year. Overholser also forecasts a capital budget of $8,000,000 for the year. If the firm maintains its capital budget of 50% equity and...

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Overholser Inc has forecast net income of $8,000,000 over next year. Overholser also forecasts a capital budget of $8,000,000 for the year. If the firm maintains its capital budget of 50% equity and 50% debt, how much of a dividend can Overholser pay if it follows a strict residual dividend policy?
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Solution Part A : A company has a earning of $8,000,000 and capital budget of $8,000,000 and maintains the debt equity ratio to be 1:1 that is 50% debt and 50% equity. Company have the project capital requirement of $8,000,000 and in order to maintain debt equity ratio to 1:1 company has to pay one by two from debt and one by two from equity. In other words company has to borrow $4,000,000 and use $4,000,000 to maintain 1:1 ratio leaving the residual amount of $4,000,000 i.e; $8,000,000 - $4,000,000 which is our amount of dividend. Part B In order to calculate PE ratio we need to find the earning per share which can be calculated by the following formula = Net earnings / number of outstanding share = $8,000,000 / 1,500,000 = $5.33 When we have earning per share the PE ratio would be calculated by the following formula PE ratio = Current market price / Earnings per share = $80 / $5.33 = 15 PE ratio = 15 Part C : After predicting the amount of dividend we can calculate the number of shares company can repurchase by the following formula Number of share the company can repurchase = Total Dividend amount / price per share                                                                                 = $4,000,000 / $80 = 50,000 Therefore company can repurchase 50,000 shares. Part 4 : In order to find the expected stock price after the repurchase we need to calculate the Earning per share of the remaining share = Net earnings / number of outstanding share Now we have the number of outstanding share as 1,500, XXXXXXXXXX,000 = 1,450,000 So the EPS after the repurchase would be = Net income / Outstanding share = $8,000,000 / 1,450,000 = $5.51 Our new EPS after repurchase is $5.51 Keeping the PE ratio at 15 the expected stock price after repurchase can be calculated with the below formula = EPS * PE ratio = $5.51 * 15 = $82.76 Therefore our Expected stock price after repurchase = $82.76.

Answered Same Day Dec 26, 2021

Solution

Robert answered on Dec 26 2021
106 Votes
Solution
Part A :
A company has a earning of $8,000,000 and capital budget of $8,000,000 and maintains the debt
equity ratio to be 1:1 that is 50% debt and 50% equity. Company have the project capital
equirement of $8,000,000 and in order to maintain debt equity ratio to 1:1 company has to pay
one by two from debt and one by two from equity. In other words company has to bo
ow
$4,000,000 and use $4,000,000 to maintain 1:1 ratio leaving the residual amount of $4,000,000
i.e; $8,000,000 - $4,000,000 which is our amount of dividend.
Part B
In order to calculate PE ratio...
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