if a company repurchases stock, why does financial leverage increase?
i understand that the answer is because equity goes down. But I thought treasury stock is included in equity so, I thought that eq would remain the same keeping leverage the same.
treasury stock is negative equity
Assumes my company has $100 in assets and $40 in liability, so $60 in equity (i.e. stock). Leverage is 1.67.
Now assume I take $30 to buy back stock. The cash out the door reduces assets by $30 and the repurchase reduces stock by $30, leaving me with 70 in assets, 40 in liability and 30 in equity. Leverage is now 70/30 or 2.33.
Basically think about it this way, as your debt increases relative to your equity, you are becoming more levered. Buying back stock decreases equity.
Isn’t it the case where stock repurchases are sometimes financed with debt, making the financial leverage even higher?
Yes, sometimes they are.