chapter 17 (1)

Question 1

open market repurchase

Answer 1

The most common way that firms repurchase shares. A firm announces its intention to buy its own shares in the open market, and then proceeds to do so over time like any other investor. THe firm may take a year or more to buy the shares and its not obliged to repurchase the full amount it originally statet.

Question 2

Tender offer

Answer 2

Firm offers to buy shares at a prespecified price during a short time period – generally within 20 days. The price is usually set a substantial premiumm to the current market price. The offer often depends on shareholders tendering a sufficient number of shares. If shareholders do not tender enough shares the firm may cancel the offer and no buyback occurs

Question 3

Dutch auction share repurchase

Answer 3

The firm lists different prices at which it is prepared to buy back sharees and shareholders in turn indicate how many shares they are willing to share at each price. The firm then pays the lowest price at which it can buy back its desired number of shares

Question 4

Targeted repurchase

Answer 4

A firm may also purchase shares directly from major shareholders in a targeted repurchase. In this case the purchase price is negotiated directly with the seller. A target repurchase may occur if a major shareholder desires to sell a large number of shares but the market for the shares is not sufficiently liquid to sustain such a large sale without severely affecting the price

Question 5

Dividend price before and after dividend payout explanation short

Answer 5

IN a perfect captial market when a dividend is paid the share price drops by the amount of the dividend when the stock begins to trade ex-dividend

Question 6

share repurchase share price before and after (short)

Answer 6

In perfect capital markets an open market share repurchase has no effect on the stock price and the stock price is the same as the cum dividend price if a dividend were paid instead

Question 7

homemade dividend

Answer 7

Dividend a shareholder can “make” in the case of a share repurchase by just selling stock

Question 8

High dividend payout not enough money

Answer 8

Firm can sell its shares to fund the dividend

Question 9

MM dividend irrelevance

Answer 9

In perfect capital markets, holding fixed the investment policy of a firm, the firms chocie of dividend policy is irrelevant and does not affect the initial share price

Question 10

Do taxes affect investors preference for dividends versus share repurchase?

Answer 10

When a firm pays a dividend, shareholders are taxed according to the dividend tax rate. If the firm repurchases shares instead and shareholders sell shares to create a homemade dividend, the homemade dividend will be taxed according to the capital gains tax rate.

If dividends are taxed at a higher rate than capital gains, which was true prior to 2003, shareholders will prefer share repurchases to dividends. And although recent tax code changes equalized the tax rates on dividends and capital gains, because capital gains taxes are deferred until the asset is sold, there is still a tax advantage for share repurchases over dividends for long term investors

Question 11

dividend puzzle

Answer 11

Why firms continue to issue dividends despite their tax disadvantage

Question 12

After tax cash flow from a dividend (formula)

Answer 12

Div(1-Td)

Question 13

after tax loss on capital gains

Answer 13

(Pcum - Pex)*(1-Tg)

Question 14

When is there an arbitrage opportunity (dividend or share repurchase payout policy)

Answer 14

When (Pcum -Pex)*(1-Tg) =/ Div(1-Td)

OR

Pcum - Pex =/ Div(1-Td/1-Tg) = Div(1-T*d)

Question 15

Effective dividend taxrate T*d

Answer 15

T*d = (Td-Tg/1-Tg)

Question 16

Effective dividend tax rate T*d

Answer 16

Measures the additional tax paid by the investor per dollar of after-tax capital gains income that is instead received as dividend

Question 17

Example: Td = 39% and Tg =20%

Answer 17

T*d = 0.39 - 0.2/1-0.2 = 23,75%

This indicates a significant tax disadvantage of dividends; each 1$ of dividends is worth only 0,7625 in capital gains.

Question 18

The effective dividend tax rate T*d for an investor depends on the tax rates the investor faces on dividends and capital gains. These rates differ across investors for a variety of reasons:

Answer 18

income level

Investment horizon (capital gains on stocks held one year or less, and dividends on stocks held for less than 61 days, are taxed at higher ordinary income tax rates)

Tax jurisdiction (U.s. investors are subject to state taxes that differ by state)

Type of investor or investment account (stock held by individual investors in a retirement account are not subject to taxes on dividends or capital gains)

Question 19

Four different types of investors
1) buy and hold
2) investor who holds the stock in a taxable account but plans to sell it after one year
3) A pension fund
4) a corporation

Answer 19

Buy and hold investor: Td = 20% Tg = 0 and T*d = 20%

one year individual investor: Td=20% Tg=20% T*d = 0%

Pension fund Td= 0 Tg = 0 T*d =0

Corporation: given a corporate tax rate of 35% Td = (1-70%=35% = 10,5%
Tg = 35% and Td = -38%

Question 20

Corporations that hold stocks are able to

Answer 20

Exclude 70% of dividends they receive from corporate taxes, but are unable to exclude capital gains

Question 21

Negative effective dividend rate for corporations implies

Answer 21

A tax advantage associated with dividends