Reading 31: Dividends and Share Repurchases: Analysis-LOS g 习 2011, between, amount, center, choice

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Session 8: Corporate Finance
Reading 31: Dividends and Share Repurchases: Analysis

LOS g: Discuss the choice between paying cash dividends and repurchasing shares.

 

 

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

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

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

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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) $31.25 $37.00

B) $31.25 $34.00

C) $34.00 $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.

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The following information is from the 10-k of Laura’s Chocolates, Inc.(LC), a maker of nut-based toffees.

Cash	25,000,000
Share price	40.00
Shares outstanding (prior to transaction)	20,000,000

LC decides to spend $20 million repurchasing common stock. What is the value of a share of stock after the share repurchase?

A) 35.00.

B) 45.00.

C) 40.00.

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Which of the following statements about a stock repurchase is least accurate?

A) Disgruntled stockholders are forced to sell their shares, improving management's position.

B) A stock repurchase occurs when a large block of stock is removed from the marketplace.

C) Management can distribute cash to shareholders without signaling about future earnings.

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A repurchase gives stockholders a choice. They can sell or not sell.

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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.