why is #5 a reason that a share buyback would be viewed favorably? 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, 3, 4, and 5. B) Reasons 2 and 3 only. C) Reasons 1 and 3 only. Your answer: B was incorrect. The correct answer was A) Reasons 2, 3, 4, and 5. 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.
i get it now, reason 5 was just worded oddly. a share buyback program is essentially an implicit residual dividend policy - since a share buyback and a cash dividend are basically the same thing, a firm buying back equity at its discretion is the same as a residual dividend policy (pay cash out when practicable). share buybacks accomplish the same thing but may be viewed differently because they don’t subject the firm to unpredictable dividends. share buybacks are not previously declared like residual dividend policies.