Finance Assignment

TASK 8

Team 1:

Adetolani Adeosun

Lawrence Henderson

Ayoub Mfinanga

Brittany Raines

Matthias Wurster

Memo to CFO

Executive Summary:

It is the opinion of this advisory committee that a share repurchase be done instead of a dividend distribution. Strictly by increase in EPS, a share repurchase will add more value than a dividend distribution. As shown below, a dividend distribution of the $5,000,000 would add $0.3333 to EPS, while the share repurchase adds $0.3378 per share. This along with tax savings to our shareholders makes the share repurchase the better option. This is even more advisable if it is likely our share price will increase in the near future, possibly due to successful invested projects. These shares can also be used in new ways such as starting a benefit/incentive program for employees, or changing our capital structure to improve our WACC. This being said, if these funds could be better used as investments in projects, then this may be the better option as it may show a weak management of the funds if a share repurchase is used over reinvestment. Also, if we are trying to establish consistent dividends, then that may also be a consideration. Overall though, with these two factors in mind, we still recommend the stock repurchase over a dividend distribution.

Analysis:

Given: Available capital $ 5,000,000

Stock available at $25 a share.

Number of shares outstanding from Task 5 are 15,000,000

Number of shares repurchased.

$ 5,000,000/25 = 200,000 shares.

Number of Shares will be outstanding after the stock repurchase is completed.

= 15,000,000 – 200,000 = 14,800,000 shares.

If Dividend is Distributed:

$5,000,000/15,000,000 = $0.3333 per share

If Shares are Repurchased:

Current Value per share = $25

Total Market Cap: $25 x 15,000,000 = $375,000,000

New distribution of market cap: $375,000,000/14,800,000 = $25.3378 per share

Increase in Value: $0.3378 per share

Benefits of repurchasing shares:

1. It prevents a decline in the value of a stock by reducing the supply of the stock.

2.With the reduction in outstanding shares, the Earnings Per Share (EPS) of the company improves. This is a good indication of the company’s profitability and may boost its share price in the long run.

3. A repurchase announcement may be viewed as a positive signal that management believes the shares are undervalued.

4. Stockholders have a choice if they want cash, they can tender their shares, receive the cash, and pay the taxes, or they can keep their shares and avoid taxes. on the other hand, one must accept a cash dividend and pay taxes on it.

5. If the company raises the dividend to dispose of excess cash, this higher dividend must be maintained to avoid adverse stock price reactions. A stock repurchase, on the other hand, does not obligate management to future repurchases.

6. Repurchased stock, called treasury stock, can be used later in mergers, when employees exercise stock options, when convertible bonds are converted, and when warrants are exercised. Treasury stock can also be resold in the open market if the firm needs cash.

7. Repurchases can be varied from year to year without giving off adverse signals, while dividends may not.

8. Repurchases can be used to produce large-scale changes in capital structure.

Cons of repurchases:

1. A repurchase could lower the stock’s price if it is taken as a signal that the firm has relatively few good investment opportunities. A repurchase can signal stockholders that managers are not engaged in empire building, where they invest funds in low-return projects.

2. The repurchase was primarily to avoid taxes on dividends, then penalties could be imposed. Such actions have been brought against closely-held firms, but to our knowledge charges have never been brought against publicly held firms.

3. Selling shareholders may not be fully informed about the repurchase hence they may make an uninformed decision and may later sue the company. to avoid this, firms generally announce repurchase programs in advance.

4. The firm may bid the stock price up and end up paying too high a price for the shares. in this situation, the selling shareholders would gain at the expense of the remaining shareholders. this could occur if a tender offer were made and the price was set too high, or if the repurchase was made in the open market and buying pressure drove the price above its equilibrium level.

5.It may indicate that the company doesn’t have any profitable opportunities to invest in, which may send a bad signal to long term investors looking for capital appreciation.

6, It may also give a negative signal about the company’s confidence and promoters may decide to sell their stake.

7.The buyback process is time-consuming and requires disclosures to stock exchanges and approvals from regulatory bodies. It also involves hiring investment bankers, which becomes an expensive affair for the company

Dividend provides a regular stream of cash for investors. It allows the shareholder to remain invested in the company and still receive regular cash flows. Cash dividend can be a big incentive for investors who rely heavily on their investments to meet their living expenses, especially retired investors who may not have another source of income.

Dividends are straightforward: the company pays a certain amount for each stock held, usually on a quarterly basis

Since the size of a dividend payout is smaller compared to a buyback, it allows the company to maintain a conservative capitalization structure every quarter rather than just hold large piles of cash.

Repurchased stock is clearly a more the tax-efficient way to return capital to shareholders because the investor doesn’t incur any additional tax on the buyback sale process. Tax is only applicable on the actual sale of shares, whereas dividends attract tax in the range of 15% to 20%. In some countries, dividend payments also attract a Dividend Distribution Tax (DDT), which means for every $1.00 paid to shareholders, the company must pay $1.20 or $1.30 depending on the DDT rate. This process favors the concept of buybacks more than cash dividends.

Buybacks are a less direct way of returning cash to shareholders. Under a share buyback, a company purchases a certain number of its own shares. It may do this on the open market, like everyone else, or by making a tender offer to shareholders, usually at a slight premium to the market price. It then cancels the purchased shares, reducing the total number outstanding and so making each share worth that much more.

Conclusion:

The number of shares will be outstanding after the stock repurchase is completed. Stockholders have a choice if they want cash, they can tender their shares, receive the cash, and pay the taxes, or they can keep their shares and avoid taxes. If the company raises the dividend to dispose of excess cash, this higher dividend must be maintained to avoid adverse stock price reactions. A stock repurchase, on the other hand, does not obligate management to future repurchases.

References

Corporate Finance Institute. (2019). Dividend vs. Share Buyback/Repurchase. Retrieved from https://corporatefinanceinstitute.com/resources/knowledge/finance/dividend-vs-share-buyback-repurchase/

Fraser, Chad. (2012, June 3). Dividends vs. Share Buybacks: The Pros and Cons. Retrieved from https://www.thestar.com/business/personal_finance/2012/06/03/dividends_vs_share_buybacks_the_pros_and_cons.html