Reading 29: Dividends and Dividend Policy-LOS l 习题精选 following, 2010, generate, border

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Session 8: Corporate Finance
Reading 29: Dividends and Dividend Policy

LOS l: Discuss the rationales for share repurchases and explain the signals that share repurchases may generate.

 

 

 

All of the following are reasons for a stock repurchase EXCEPT:

A) the corporation may purchase its shares at a bargain.

B) repurchases can be used to decrease supply of the stock, thus increasing the share price.

C) investors see repurchases as a signal that shares are overvalued.

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Repurchases are viewed as a signal by the company that shares are undervalued - worth more than their going price. Shareholders who do not believe the shares are worth more can sell them, while more-supportive shareholders can retain share ownership. A company can also use share repurchases to alter their capital structure by changing the mix of debt and equity.

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Belden Engineering Corporation (BEC) is considering a share repurchase program. David Gudzanski, the firm’s executive vice president prepares a memo to the board of directors detailing reasons why a share repurchase would be favorable at this time. Reasons listed in the memo are as follows:

Reason 1: The resulting capital structure from the share repurchase would be more favorable for investors in BEC’s bonds.

Reason 2: BEC’s stock is currently selling at $37 in the marketplace. Our discounted cash flow analysis values the company at $48 per share.

Reason 3: The share repurchase could be used to offset dilution caused by the exercise of employee stock options.

Reason 4: BEC can use the repurchase to send a signal to investors that management has a positive future outlook for the company.

Reason 5: The share repurchase could be used to implement a residual dividend policy while diminishing the potential increase in perceived risk that such a policy would cause for investors.

Which of Gudzanki’s reasons in favor of the share repurchase is most accurate?

A) Reasons 2 and 3 only.

B) Reasons 1 and 3 only.

C) Reasons 2, 3, 4, and 5.

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A share repurchase would decrease the percentage of equity in a firm’s capital structure, which would in turn increase the percentage of debt. An increase in debt would add more leverage to the firm which would be negative for the firm’s bondholders. The other reasons listed are all rationales for a share repurchase.

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Wanda Brunner, CFA, notes that her top equity position, Theibolt Corp, has initiated a share repurchase program. The least likely reason for this is:

A) management has no positive Economic Value Added (EVA) projects in their industry, and is returning cash to shareholders.

B) management wants to send a signal to investors that the future outlook is positive.

C) it prevents earnings per share (EPS) dilution that comes from the exercise of employee stock options.

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The five primary rationales for share repurchases are:

• Management wants to send a signal to investors that the future outlook is positive.
• It prevents EPS dilution that comes from the exercise of employee stock options.
• Provide the economic equivalent of a dividend without a long-term commitment.
• The company views its own stock as a strong investment.
• Management is changing the capital structure of the company by decreasing the percentage of equity.