## Answers to Chapter Review and Self Test Problems

18.1 Readata has a debt-equity ratio of .60/.40 = 1.50. If the entire \$5,000 in earnings were reinvested, then \$5,000 X 1.50 = \$7,500 in new borrowing would be needed to keep the debt-equity ratio unchanged. Total new financing possible without external equity is thus \$5,000 + 7,500 = \$12,500.

If planned outlays are \$12,000, then this amount will be financed with 40 percent equity. The needed equity is thus \$12,000 X .40 = \$4,800. This is less than the \$5,000 in earnings, so a dividend of \$5,000 - 4,800 = \$200 will be paid.

18.2 The market value of the equity is \$2,500. The price per share is \$25, so there are 100 shares outstanding. The cash dividend would amount to \$500/100 = \$5 per share. When the stock goes ex dividend, the price will drop by \$5 per share to \$20. Put another way, the total assets decrease by \$500, so the equity value goes down by this amount to \$2,000. With 100 shares, the new stock price is \$20 per share. After the dividend, EPS will be the same, \$2.50, but the PE ratio will be \$20/2.50 = 8 times.

With a repurchase, \$500/25 = 20 shares will be bought up, leaving 80. The equity will again be worth \$2,000 total. With 80 shares, this is \$2,000/80 = \$25 per share, so the price doesn't change. Total earnings for Gothic must be \$2.50 X 100 = \$250. After the repurchase, EPS will be higher at \$250/80 = \$3.125. The PE ratio, however, will be \$25/3.125 = 8 times. ## Insiders Online Stocks Trading Tips

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