solution

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 $45 and the number of shares outstanding for Cisco’s stock is 5,100,000,000 shares.

Rather than selling all remaining shares today, now you decide to consider a longer holding period.
That is, you will sell all remaining shares in 5 years rather than immediately. Assume that the stock
price will grow at 10% rate per year going forward, regardless of what the starting price is today.
Also assume that Cisco will pay no other dividend over the next 5 years.
Note that these liquidation proceeds (both after dividend payments and share repurchase) are
subject to capital gain taxes (15% tax rate) regardless of when you sell the shares.
9. What would be the stock price after 5 years under each scenario (i.e. the dividend and share
repurchase scenario)? (0.3 points)
Hint: you can compute the future value of the current stock price.
10. What is the after-tax liquidation proceeds from selling remaining shares 5 years after the
dividend payment? (0.5 points)