Reading 38- Dividends and Share Repurchases: Basics

BVPS after buyback=

# shares buyback= repurchase amount $/ share price remaining shares= shares outstanding - number shares buyback Book Value before repurchase= shares outstanding*BVPS Book Value after repurchase= Book value before repurchase- repurchase amount $ Book Value per Share (BVPS)= Book Value after repurchase/ remaining shares

(4) ways of a share repurchase:

1. buy in the open market (+) flexibility in timing and changing amounts repurchased (-) slow 2. buy a fixed number of shares (tender offer) at a FIXED price (+) quick (-) company has to offer a premiym 3. Dutch auction= tender offer: acceptable range of prices for a specific number of shares (+) lower price, quick 4. repurchase by direct negotiation= negotiate directly with a large shareholder to buy back a block of shares, usually at a premium over market price

earnings yield (E/P)=

EPS/price $1/$20= 5% earnings yield < after-tax cost of debt --> EPS decreases

If an investor purchases shares of stock on or after the ex-dividend date, will she receive the dividend?

NO because you must purchase the stock the day BEFORE EX-DIVIDEND DATE ex-dividend date is always 2 days before holder-of-record date

dividend payout chronology

declaration date= board of directors approves payment of dividend ex-dividend date (no $$ yet) T-2= first day a share of stock trades without the dividend; cutoff date for receiving the dividend- 2 business days before holder-of-record date holder-of-record date T= date on which shareholders of record are designated to receive the dividend payment date= date the dividend checks are mailed out

book value per share will _____ if repurchase price is greater than the original book value per share.

decrease

A share repurchase will ____ the number of shares outstanding, and ____ the earnings per share

decrease; increase

liquidating dividends

distribute proceeds to shareholders when a company is going out of business

dividend payout ratio=

dividends per share/ EPS

A share repurchase is ____ to a cash dividend, assuming tax treatment of the two alternatives is the same.

equivalent

likely opening price of a stock after dividend ex-date

(last traded price on ex-date-1) - (dividend)

EPS after buyback=

(total earnings- after tax cost of funds)/shares outstanding after buyback =(EPS*shares before buyback- yield on new debt(1-tax rate))/ (shares outstanding- shares repurchased)

Paying a cash dividend is most likely to result in: A) an increase in financial leverage ratios. B) an increase in liquidity ratios. C) the same impact on liquidity and leverage ratios as a stock dividend.

A A cash dividend will increase leverage ratios such as debt-to-equity and debt-to-assets, reflecting a decrease in the denominator. A cash dividend should decrease liquidity ratios such as the current ratio and cash ratio, due to the decrease in cash in the numerator. Unlike a cash dividend, a stock dividend or a stock split has no impact on liquidity or financial leverage ratios.

What is the earliest day on which an investor can currently purchase Amex, Inc., if the investor wants to avoid receiving a dividend and thereby avoid paying tax on the distribution, if the date of record is Thursday, October 31? A) Tuesday, October 29. B) Monday, October 28. C) Thursday, October 24.

A The ex-dividend date is now two business days prior to the date of record. Counting back two business days identifies Tuesday, October 29 as the date when the shares can be purchased without the dividend.

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

B 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.

Which justification for repurchasing stock is the least valid? A) Repurchases offer shareholders more choices than cash dividends. B) Shareholders prefer capital gains to cash dividends. C) A cash dividend increase, in response to short-term excess cash flows, may confuse investors.

B Some shareholders prefer capital gains, while others prefer dividends. Repurchases offer shareholders the choice of tendering or not tendering their stock, while cash dividends represent a payment they cannot refuse. Raising dividends is often seen as a positive signal, but an increase funded by short-term cash flows may not be sustainable, forcing the company to reduce the dividend later.

A periodic payment to shareholders in the form of additional shares of stock instead of cash is a: A) dividend reinvestment plan B) stock dividend C) stock repurchase

B Stock dividends are dividends paid out in new shares of stock instead of cash. Unlike stock dividends, dividend reinvestment plans are at the discretion of individual shareholders. In the case of stock repurchases, the company is buying back shares so the number of shares in the investment public's hands is declining.

The share price of Winnipeg Auto Unlimited is $5 per share. There are 50 million shares outstanding, and Winnipeg has a book value of $900 million. What is the book value per share (BVPS) after the share repurchase of $10 million? A) $21.24. B) $18.54. C) $14.76.

B The share buyback is $10 million / $5 per share = 2,000,000 shares. Remaining shares: 50 million − 2 million = 48 million shares. Winnipeg Auto Unlimited's current BVPS = $900 million / 50 million = $18. Book value after repurchase: $900 million − $10 million = $890 million. BVPS = $890 million / 48.0 million = $18.54. BVPS increased by $0.54. Book value per share (BVPS) increased because the share price is less than the original BVPS. If the share prices were more than the original BVPS, then the BVPS after the repurchase would have decreased.

Which of the following statements about a stock repurchase is least accurate? A) A stock repurchase occurs when a large block of stock is removed from the marketplace. B) Management can distribute cash to shareholders without signaling about future earnings. C) Disgruntled stockholders are forced to sell their shares, improving management's position.

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

Financial managers utilize stock splits and stock dividends because they perceive that: A) investors will double the share price if there is a 20% stock dividend. B) brokerage fees paid by shareholders will be reduced. C) an optimal trading range exists.

C Although there is little empirical evidence to support the contention, there is nevertheless a widespread belief in financial circles that an optimal price range exists for stocks. "Optimal" means that if the price is within this range, the price/earnings ratio, price/sales and other relevant ratios will be maximized. Hence, the value of the firm will be maximized.

Jim Davis and Thurgood Owen, two equity analysts at Ferguson Capital Management, were reviewing the financial statements of Peregrine Foodstuffs Ltd. Davis and Owen noticed that Peregrine has been repurchasing its common shares in the market over the past three years. Owen thought this was an important issue to look into in greater detail. Upon completion of his review, Owen made the following two statements: Statement 1: Peregrine has bought back shares in the open market during its repurchase program. This method of repurchase gave the company the flexibility to choose the timing of the transaction. Statement 2: Peregrine plans to buy back shares by making tender offers during the coming year. By making tender offers, the company will be able to repurchase shares at a discount to the prevailing market price. With respect to Owen's statements: A) both are correct. B) both are incorrect. C) only one is correct.

C Buying in the open market gives the company the flexibility to choose the timing of the transaction. Thus, Statement 1 is correct. A second way is to buy a fixed number of shares at a fixed price. A company may repurchase stock by making a tender offer to repurchase a specific number of shares at a price that is at a premium to the current market price. They would not be willing to tender their shares for less than the prevailing market price, so Statement 2 is incorrect.

The share price of Solar Automotive Industries is $50 per share. It has a book value of $500 million and 50 million shares outstanding. What is the book value per share (BVPS) after a share repurchase of $10 million? A) $10.12 B) $10.00. C) $9.84.

C The share buyback is $10 million / $50 per share = 200,000 shares. Remaining shares: 50 million − 200,000 = 49.8 million shares. Solar Automotive Industries' current BVPS = $500 million / 50 million = $10. Book value after repurchase: $500 million − $10 million = $490 million. BVPS = $490 million / 49.8 million = $9.84. BVPS decreased by $0.16. Book value per share (BVPS) decreased because the share price is greater than the original BVPS. If the share prices were less than the original BVPS, then the BVPS after the repurchase would have increased.

regular dividend

company pays out portion of profits on a consistent schedule (ex. quarterly) indicates financial stability

Book value per share will ______ after a share repurchase if the company's after-tax borrowing rate is greater than the company's earning yield.

increase

For reverse stock splits and stock splits, does shareholder wealth change?

no- the market value doesn't change decrease shares= increase in price, and vice versa

special dividends aka extra, irregular dividends

one-time cash payment to shareholders, share profits with shareholders when times are good

share repurchase: book value per share increases if

share price is less than original BVPS

share repurchase: book value per share decreases if

share price is more than original BVPS

P/E ratio=

stock price/ earnings per share $20/$1= 20