1. FIN 614: Financial Management Larry Schrenk, Instructor

2. 1.What are Stock Repurchases? 2.Repurchases versus Dividends 3.Advantage and Disadvantages of Stock Repurchases

3. Repurchases: Firm buying own stock back from stockholders. Firm announces intent to repurchase stock. Three ways to purchase: Have broker purchase on open market over time. Make a tender offer to shareholders. Make a block (targeted) repurchase. Firm doesn’t have to complete its announced intent to repurchase.

4. Note that stock price drops by dividend per share in model. If it didn’t there would be arbitrage opportunity (assuming no taxes). In real world, stock price drops on average by about 90% of dividend.

5. Announcement of a repurchase might send a signal that affects stock price, but the actual repurchase has no impact on stock price: If investors thought that the repurchase would increase the stock price, they would all purchase stock the day before, which would drive up its price. If investors thought that the repurchase would decrease the stock price, they would all sell short the stock the day before, which would drive down the stock price.

6. $10=/100,000$1,000,000 = Price per share 100,000 = outstanding Shares 1,000,000Value of Firm1,000,000Value of Firm 1,000,000Equity850,000 AssetsOther 0Debt$150,000Cash sheet balance Original A. Equity &Liabilities Assets Consider a firm that wishes to distribute $100,000 to its shareholders.

7. $9=00,000$900,000/1 = shareper Price 100,000=outstanding Shares 900,000Firm of Value900,000Firm of Value 900,000Equity850,000AssetsOther 0Debt$50,000Cash dividendcash shareper $1After B. Equity & Liabilities Assets If they distribute the $100,000 as a cash dividend, the balance sheet will look like this:

8. Assets Liabilities&Equity C. After stock repurchase Cash$50,000Debt0 Other Assets850,000Equity900,000 Value of Firm900,000Value of Firm900,000 Shares outstanding=90,000 Price pershare= $900,000/90,000=$10 If they distribute the $100,000 through a stock repurchase, the balance sheet will look like this:

9. Tax break for investors Unwillingness to cut dividends Price pop after a repurchase As an alternative to distributing cash as dividends To dispose of one-time cash from an asset sale To make a large capital structure change To use when employees exercise stock options

10. Stockholders can choose to sell or not Avoids a high dividend that cannot be maintained Income received is capital gains rather than higher-taxed dividends Stockholders may take as a positive signal that stock is undervalued

11. May be viewed as a negative signal (firm has poor investment opportunities) IRS could impose penalties if repurchases were primarily to avoid taxes on dividends

12. Repurchase Stock price doesn’t fall at time of repurchase Number of shares falls Dividends Stock price falls by amount of dividend at time of payment Number of shares doesn’t change

13. FIN 614: Financial Management Larry Schrenk, Instructor