Mini Case Gilbert Enterprise Essay
The firm’s stocks are undervalued. According to the dividends, growth rate, and discount rate the share price should be $43. 36 which is $8. 11 higher than the current market price. If the repurchase of $1Million worth of shares occurs, the company’s Return on Equity would increase. This would happen since there is less shareholder’s equity in the company due to the lower amount of shares outstanding. Currently the company’s Return on Equity is better than Standard Auto and Allied Motors but worse than Reliance Parts.
The chances are that the change will not affect the company’s ranking compared to the other companies since Reliance Parts is 7. 3% higher, although there will be an increase, it will most likely not be high enough to make up the large difference of 7. 3%. The company’s earnings per share would increase if the repurchase occurs as a result of the decreased amount of shares in circulation. At the current dividend per share price of $1. 20 then the dividend yield will decrease since stock prices will go up as a result of the repurchase. The new dividend yield after the repurchase will be 2. 8% (1. 0/43. 36).
The company currently has the second best dividend yield. According to the data, Reliance Parts and Allied have a worse dividend yield than Gilbert Enterprise. Standard Auto has a better dividend yield by 1. 86%. If the company chose to repurchase the stock it will then have a lower dividend yield than Allied Motors as well as Standard Auto. In future years, with the dividend having a 15% growth rate over the next three years, the dividend yield will increase. The dividend yield after year one assuming that stock price remains constant at $43. 36 then dividend yield will be 3. 18% (1. 8/43. 36) which would make us second best as long as the dividend yield for the other companies remains constant.
The dividend yield after the second year again assuming that the price remains constant at $43. 36 then dividend yield will be 3. 67% (1. 59/43. 36). We can conclude that it will take the company a while to rank first as long as the other companies remain constant. One way to counter the decrease in dividend yield would be to pay out the savings that would occur from the buy back of the stocks and paying those out to our current stock holders. If we can get dividends per share up to $1. 7(43. 36 x 3. 4%) per share this would bring our dividend yield back to 3. 4%. It is also important to consider the method that would be used to repurchase the stock. If debt is to be used in the repurchase, than the debt to total asset will increase. Currently the company’s debt to total asset is better than Reliance Parts and Allied Motors but worse than Standard Auto by 8%. The chances are that the $1Million increase in debt will increase the debt to total assets ratio by more than 3% which would then make Allied Motors’ debt to total assets’ ratio better than ours.
The only way that this would not be true is if the total assets are greater than $33,333,333 (1,000,000/3%) which is highly unlikely. It is also important to ensure that the company is financially capable of carrying the additional debt since there will be additional interest expense due to this debt. If however, the company decides to use cash to repurchase the stock, then the return on assets would increase assuming that the extra cash expenditure does not affect the company’s earnings for the year and their debt to total assets ratio would also increase since the company will have less assets.
Currently Gilbert Enterprise has the best Return on total assets compared to Reliance Parts, Standard Auto, and Allied Motors. The second best company trailing behind us is Standard Auto by 1. 6%. Therefore the change in return on total assets ratio, due to the repurchase, would not affect the ranking since the return on total assets would increase. As mentioned before, the company’s debt to total assets ratio ranks second. The chances are that the $1Million decrease in assets will increase the debt to total assets ratio by more than 3% which would then make Allied Motors’ debt to total assets ratio better than ours.
If the company decides to use both debt and cash to support the repurchase of the stock then the return on assets will decrease and the debt to total assets ratio could either increase or decrease depending on how large their debt is, how large their assets are, and how they split the repurchase i. e. more cash than debt. However, the decrease and the increase will not be as substantial as it would be if the company were to choose a single method of financing the repurchase.
We would strongly recommend that the company use a split that would allow the company’s debt to total assets ratio to not increase above Allied Motors’ debt to total assets ratio. If we assume that earnings will be unchanged due to the repurchase then for P/E ratio to increase, then earnings per share must increase from 2. 1 (35. 25/16. 8) to 2. 58 (43. 36/16. 8). If this occurs then there is no change in P/E ratio, however, if earnings per share are less than 2. 58, P/E ratio will increase and if earnings per share are greater than 2. 8, then P/E ratio will decrease. Currently the company’s P/E ratio is better than Standard Auto but worse than Reliance Parts and Allied Motors. If the replacement value is $43. 50 we can conclude that there will be an increase in replacement cost. This means that the higher the replacement value the more the company will spend on replacing its assets. Currently Gilbert enterprise is second worse compared to Standard Auto and Allied Motors but better than Reliance Parts.
In the end, our recommendation is that the company go ahead with the repurchase since this would increase the share price, and could potentially increase dividends per share, would increase return on total assets and if the payment method of the repurchase is structured properly, it would not have any effect on the company’s debt to total assets ratio will not change. I strongly recommend that they use debt and cash to finance the repurchase to ensure that debt to total asset does not change. We can conclude that the firm’s stock is undervalued.