If you repurchase shares, does your leverage change?
I don’t get their explanation of the correct answer below in italics!
Question repurchasing shares would least likely be tru
a) increase leverage
b) signal the market that despite declinining share price future prospects look good
c) will reduce the wealth of all shareholders, including those who tender their shares for repurchase if the repurchase price is at a premium to the current stock price.
Paying a premium price for shares will reduce the value of the remaing shareholders shares. However, this value reduction is actually transferred to the selling shareholder since they receive more than the market value per share for selling their shares.
If the only change is repurchasing shares, then yes, the leverage increases. Also, a company repurchasing its shares can signal that it believes its shares are currently undervalued (a cheap buy).
Their explanation says that if the company pays a premium price to tendering shareholders in the market, then more value is being taken from the firm (and remaining shareholders) and given to the selling shareholders. Therefore, the wealth of ALL shareholders is not reduced, only those who do not tender their shares.
Think of this quick and simple example: Ten people pay $10 to join a club. Each member has a $10 share ($100 over 10 members). The club then offers the first 5 people $11 (each) to leave the club. Now, only $45 remains in the club for 5 remaining members. The value of the membership per person that remains in the club is $9 ($45/5). They have lost one dollar, and the people who left gained $1 dollar.
Thank you!!! I got the answer below verbatim from my mock. I still don’t agree with the bold sentenc below. here is way!
Paying a premium price for shares will reduce the value of the remaing shareholders shares. However, this value reduction is actually transferred to the selling shareholder since they receive more than the market value per share for selling their shares.
*** the value reduction is transferred to the remaing shareholders, not the selling s/h, correct?***
Glad to help. I don’t see a problem with their sentence. They’re saying the reduction occurs to the wealth of the remaining shareholders, and the wealth reduction is transferred [as a gain] to those who sold off shares in the buyback. They could make the sentence a littler clearer, though, which I think is your point.