Chapter 11.2 Flashcards
Stock Repurchases
Besides paying out dividends, what’s another popular method of distributing value to stockholders?
Stock repurchases
What is a stock repurchase?
The purchase of stock by a company from its stockholders; an alternative way for the company to distribute value to the stockholders
How do stock repurchases differ from dividends?
- Don’t represent a pro-rata distribution of value to the stockholders
- When a company repurchases its own shares, it removes them from circulation
- Taxed differently than dividends
- Accounted for differently on the balance sheet
How do stock repurchases not represent a pro-rata distribution of value to the stockholders?
Because not all stockholders participate
How does the choice of participating differ in stock repurchases and dividends?
Individual stockholders decide whether they want to participate in a stock repurchase. Some stockholders participate while others don’t.
In a dividend distribution, all stockholders receive the dividend
What happens when a company repurchases its own shares and removes them from circulation?
Reduces the number of shares of stock held by investors
How does a company removing its own shares from circulation when repurchasing them impact ownership of the firm?
Removing a large number of shares from circulation can change the ownership. Can increase/decrease the fraction of shares owned by major stockholders thereby diminish ability to control the company
What can happen if a company w/ relatively small number of shares in the public market distributes a lot of cash to investors through a stock repurchse?
There will be less liquidity for the remaining shares
What is an extreme example of there being less liquidity for remaining shares when companies w/ small number of shares distributes lots of cash to investors thru a stock repurchase?
When a public company repurchases most of its outstanding shares and “goes private”
Why does a dividend not have the same effects as stock repurchases on ownership and liquidity?
Since a dividend doesn’t affect who owns the shares or the number of shares outstanding
How are stock repurchases taxed differently than dividends?
Dividends: Total value of dividends normally taxed
Repurchase: when stockholder sells shares back to the company, only taxed on the profit from the sale
Suppose a stockholder purchased 100 shares for $150 and then sold them to the company for $200 a year later. How much profit did the stockholder earn on the sale that would be treated as a capital gain?
$200 − $150 = $50
Suppose a stockholder purchased 100 shares for $150 and then sold them to the company for $200 a year later. In this example, the $50 profit that the stockholder earned on the sale would be treated as a capital gain and would be taxed at no more than a 23.8 percent rate depending on the stockholder’s income. What is the maximum total tax on the sale of the stock?
How would this compare to if the company had distributed the $200 as a dividend?
$11.90 ($50 × 0.238 = $11.90)
$47.60 ($200 × 0.238 = $47.60)—four times as much
How are profits that stockholders earn on the sales of shares back to companies in stock repurchases treated as when taxed?
As a capital gain and would be taxed no more than a 23.8% rate (the max rate on capital gains in 2013)
Why is the difference between taxation on repurchases and dividends even more significant when you remember a dividend is not optional?
Stockholders who receive dividends have no choice as to when they must pay the tax
Since stockholders choose whether to participate in repurchase plan: able to choose when they pay taxes on the profit from selling their stock
Give an example of how dividends are accounted for on the balance sheet.
When a company pays a cash dividend: cash account on assets side of balance sheet and the retained earnings account on the liabilities and stockholder’s equity side of the balance sheet are reduced
Give an example of how stock repurchases are accounted for on the balance sheet.
Company uses cash to repurchase stock: cash account on assets side of balance sheet reduced, treasury stock account on liabilities and stockholders’ equity side of the balance sheet is increased (becomes more negative)
What are the 3 general ways companies can repurchase stock?
- Open-market repurchases
- Tender offer
- Targeted stock repurchases
What are open-market repurchases?
The repurchases of shares by a company in the open market
What is a company simply purchasing shares in the market, much as an individual would do, called?
Open-market repurchases
What is a benefit of open-market repurchases?
Convenient way of repurchasing shares on an ongoing basis
Give an example of how open-market repurchases are a convenient way of repurchasing shares on an ongoing basis?
A company might use such repurchases to distribute some of its profits instead of paying a regular cash dividend
Why are open-market repurchases not beneficial when a company has a large amount of cash to distribute?
Because the government limits the number of shares that a company can repurchase on a given day
Why does the government limit the number of shares that a company can repurchase on a given day in open-market repurchases?
Intended to restrict the ability of firms to influence their stock price through trading activity
