no plagiarism

9. Dividend payments Seashore Salt Co. has surplus cash. Its CFO decides to pay back $4 per share to investors by initiating a regular dividend of $1 per quarter or $4 per year. The stock price jumps to $90 when the payout is announced.

a. Why does the stock price increase?

Answer: An announcement of a dividend increase is good news to investors. Investors know that managers are reluctant to reduce dividends and will not increase dividends unless they are confident that the payment can be maintained. Therefore announcement of a dividend increase signals managers’ confidence in future profits, and thus the stock price rises with the announcement.

b. What happens to the stock price when the stock goes ex dividend?

Answer: On the ex-dividend date the price will fall by approximately the dividend amount ($1) because buyers of the stock on the ex-dividend date are not entered on the company’s books before the record date and not entitled to the dividend.




10. Repurchases Look again at Problem 9. Assume instead that the CFO announces a stock repurchase of $4 per share instead of a cash dividend.

a. What happens to the stock price when the repurchase is announced? Would you expect the price to increase to $90? Explain briefly.

Answer: The announcement of a share repurchase is not a commitment to continue repurchases, so the information content of a repurchase announcement is less strong and the stock may not rise as much.

b. Suppose the stock is repurchased immediately after the announcement. Would the repurchase result in an additional stock-price increase?

Answer: The value of any information in the announcement should be immediately priced into the stock. Thus, there should not be any additional stock-price increase.