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Problem: Cabot Vineyards has been paying a regular cash dividend of $4.80 per share each year for over a decade. The company is paying out all its earnings as dividends and is not expected to grow. There are 118,000 shares outstanding selling for $80 per share. The company has enough cash on hand to pay the next annual dividend. Suppose that Cabot announces today that starting a year from now, it will cut its cash dividend to zero and will use the cash to repurchase shares instead.
Required:
1. What is the immediate stock price reaction? Ignore taxes and assume that the repurchase program conveys no information about operating profitability or business risk.
2. How many shares will Cabot re-purchase?
3. Project and compare future stock prices for the old and new policies for the next 3 years. What is the annual return to shareholders under each of the policies?
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