Posted: November 30th, 2016

What is the number of shares that would be repurchased (at the current market price of $25) in the repurchase scenario? What is the dividend per share that could be paid in the dividend scenario?

The Case:

You are a very powerful institutional investor that holds 1 million shares of Cisco System, Inc., purchased on February 28, 2003. In researching Cisco, you discovered that they are holding a large amount of cash. Additionally, you are upset that the Cisco stock price has been somewhat stagnant as of late. You are considering approaching Cisco’s Board of Directors with a plan to payout half of the cash the firm has accumulated, but can’t decide whether a share repurchase or a special dividend would be best. Because both dividends and capital gains are taxed at the same rate (15%), at the first glance there seems to be no difference between the two options. To confirm, however, you need to “run the numbers” for each scenario. Assume that the current stock price is $25 and the number of shares outstanding for Cisco’s stock is 5,100,000,000 shares.

To help you answer the questions below, you can use information obtained from http://finance.yahoo.com.

• You can find Cisco’s cash balance under “Cash and Cash Equivalents” reported on the balance sheet (Note that the number is in thousands).

• To obtain the initial purchase price at which you bought the stock on February 28, 2003, click “Historical Prices,” enter February 28, 2003 (the date you purchased the stock) as the start date and end date, choose “Daily” frequency, and hit “Get Prices.” Record the “Adj Close” price. This is your initial purchase price.

Questions part I:

1. What is the number of shares that would be repurchased (at the current market price of $25) in the repurchase scenario? What is the dividend per share that could be paid in the dividend scenario?

2. If Cisco paid out the cash in the form of special dividends, what is the dollar amount of taxes you (the institutional investor) will pay on the dividend income? Note that you need to compute the total dividend income taxes, not just dividend income tax per share.

3. If the cash is (indirectly) paid through stock repurchase instead, payout proceeds are a little bit indirectly realized. Let’s assume that you will make a “home-made dividend” by selling some number of shares from your initial holdings. The number of shares that you can sell and still maintain the same proportion of ownership before and after repurchase program is 26,376 shares. Assuming that you can sell these shares at the current market price, what is the after-tax payout proceeds from this home-made dividend under the repurchase scenario? Note that home-made dividends, unlike actual dividends, are realized by selling stock and therefore are subject to capital gain taxes:

Capital gain taxes = (Selling price – Initial purchase price)×

Number of shares sold×Capital gain tax rate

4. Do you pay more for receiving special dividends or share repurchases? How much more?