Reading 47: Dividends and Share Repurchases: Basics-LOS f 习 equivalent, amount, center, impact, wealth

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Session 11: Corporate Finance
Reading 47: Dividends and Share Repurchases: Basics

LOS f: Explain why a cash dividend and a share repurchase of the same amount are equivalent in terms of the effect on shareholders' wealth, all else being equal.

 

 

What is the impact on shareholder wealth of a share repurchase versus cash dividend of equal amount when the tax treatment of the two alternatives is the same?

A) A share repurchase will sometimes lead to higher total shareholder wealth than a cash dividend of an equal amount.

B) A share repurchase will always lead to higher total shareholder wealth than a cash dividend of an equal amount.

C) A share repurchase is equivalent to a cash dividend of an equal amount, so total shareholder wealth will be the same.

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Assuming that the tax treatment of a share repurchase and a cash dividend of equal amount is the same, a share repurchase is equivalent to a cash dividend payment, and shareholder wealth will be the same.

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Pearl City Breweries has 8 million shares outstanding that are currently trading at $34 per share. The company is choosing whether to distribute $22 million as dividends or to use the same amount to repurchase its shares. Ignoring tax effects, what will be the amount of total wealth from owning one share of Pearl City Breweries under each of these alternatives?

Cash dividend

Share repurchase

A) $34.00 $34.00

B) $31.25 $37.00

C) $31.25 $34.00

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If the company pays a cash dividend, the dividend per share will be $22 million/8 million = $2.75. The value of its shares will be:

So the total wealth from owning one share will be $31.25 + $2.75 = $34.00.

If the company repurchases shares, it can buy $22 million/$34 = 647,058 shares. The value of one share would then be:

If you remember that both a cash dividend and a share repurchase for cash leave shareholder wealth unchanged, this question does not require calculations of the amounts.