repurchasing stock

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. D) Repurchases allow companies to alter their capital structure without issuing debt.

Interesting question. Stock repurchase is equivalent to one-time cash dividend. That might be a good idea right after short-term excess cash flow (C is correct), some shareholders might prefer capital gains depending on the tax law and their bracket (B is correct), repurchases offer additional choices (A is correct). Stock repurchase doesn’t affect capital structure - I am going with D.

I think A, because share repurchases do NOT offer shareholders more choices than a cash dividend. For some reason I thought share repurchases did alter capital structure… Great question, am looking forward to the correct answer.

Shouldn’t share repurchases affect Treasury Stock (contra account to equity)…and if so that would change the capital structure of the firm…(D/E)… I agree with A… as a cash dividend should offer more choices than stock repurchase (reinvestment income)… Correct me if I am wrong…

You are right. The capital structure does change. I guess A is the correct answer.

This is a tough one. I think B is correct b/c I think that it’s the least valid justification. It is a definite statement, and I don’t think you can universally say that all investors prefer cap gains to dividends.

Bodymore, I noticed that too about B, but IMO you can only apply it to the context of the question. It is saying “IF” shareholders prefer cap gains to cash dividends, that would be a valid justification of share repurchases vs a cash dividend.

The semantic intricacies of this question bug me as well. My first thought was B, for the reasons Bodymore pointed out.

A is perfectly valid – shareholder has the option of redeeming (and taking the immediate tax hit) or not. That’s a very valuable option. Almost all shareholders prefer stock repo to dividend (especially from the EPS uplift). With the US 2003 tax law change, B is less valid. From a global perspective (and historically) it’s more valid. C is a classic wishy-washy right-and-wrong answer, it relies on many assumptions. D - well either option for capital return to equity holders increases the firm’s leverage ratio, so it’s not clear that this is specific to repos. ------------ Final answer: E – the question is crap, move on.

I agree with E… Also, if you are in US, Dividends are taxed lower than capital gains.

E is the right answer. - Dinesh S

These tax-related questions for a global exam are sorta odd… Why would someone who lives in Dubai give a rat’s behind about US tax law?

delhirocks Wrote: ------------------------------------------------------- > Also, if you are in US, Dividends are taxed lower > than capital gains. University of Singapore?

alright hari - what is the answer?

I hope the exam has an option “E”

It has to be A, what choices does a share repurchase OR cash dividends offer shareholders? All the other choices make sense. B still makes sense in Canada, dividends taxed at effective rate, whereas only 50% of capital gains are taxed at effective rate. It’s nice not to be confused by a different system!

culley Wrote: ------------------------------------------------------- > For some reason I thought share repurchases did > alter capital structure… Any return of capital to one class of investors (rather than a proportional distribution) will do that. Here, for two reasons: + Assets drop, so with constant D the leverage increases + Many people use “net debt” for D; if so then distributing excess cash will increase D, and if you give the cash to E it has a double effect on leverage ratio. Same for either repo or div.

Dimes27 Wrote: ------------------------------------------------------- > It has to be A, what choices does a share > repurchase OR cash dividends offer shareholders? Repo is optional to the shareholder; dividend is not.

It is management discretion though, ie not a “choice” of the shareholder?

Answer is B, came across that question myself in QBank. It is also a logical answer as dividends vs capital gains depends entirely on the shareholder, so no broad judgements can be made which are applicable to all shareholders. Ex: in some countries capital gains are not taxed, or some shareholders are exempt from such taxes, while it might be the other way around in other countries.