Ch 18

Question 1

Why might a company repurchase its own stock?

Answer 1

Because the stock price is low, to maintain demand for shares, fund employee stock options, support mergers/takeovers, or reduce the number of shares outstanding.

Question 2

How does stock repurchase impact EPS?

Answer 2

Reduces the number of shares outstanding, which increases EPS (Earnings per Share).

Question 3

What is the formula for calculating shares repurchased?

Answer 3

Shares Repurchased = Excess Cash ÷ Market Price per Share

Question 4

How does stock repurchase differ from dividends in effect?

Answer 4

Both increase shareholder value, but repurchases increase EPS and potentially stock price, while dividends provide immediate cash to shareholders.

Question 5

Name 3 other reasons for stock repurchase.

Answer 5

1) Bargain price 2) Defensive against takeover 3) Improve ownership concentration

Question 6

What is a Dividend Reinvestment Plan (DRIP)?

Answer 6

A plan allowing shareholders to reinvest cash dividends into additional company shares automatically.

Question 7

Name 3 benefits of DRIPs to investors

Answer 7

1) Low/no transaction costs 2) Buy fractional shares 3) Flexibility with reinvestment

Question 8

How does a company benefit from DRIPs?

Answer 8

Increases cash flow and shareholder loyalty

Question 9

What are the two key dividend policy metrics?

Answer 9

Dividend Payout Ratio and Dividend Yield

Question 10

What is dividend stability?

Answer 10

Company’s commitment to consistently pay or grow dividends, indicating financial strength

Question 11

What influences dividend policy changes over time?

Answer 11

the firm’s life cycle, investor preferences, economic conditions, and tax policies

Question 12

Name 3 alternatives to cash dividends.

Answer 12

1) Stock dividends 2) Stock splits 3) Stock repurchases

Question 13

What is a stock dividend?

Answer 13

Distribution of additional shares instead of cash dividends

Question 14

What is a stock split?

Answer 14

increases the number of shares outstanding, reducing stock price but not shareholder value

Question 15

What is the difference between a stock repurchase and a stock split?

Answer 15

A repurchase reduces shares and increases EPS; a split increases shares but keeps total value constant

Question 16

What is the dividend relevance theory?

Answer 16

In imperfect markets, dividend policy affects firm value due to taxes, investor preferences, etc.

Question 17

What is a poison pill?

Answer 17

A defensive tactic against hostile takeovers involving rights offerings to dilute potential acquirers

Question 18

What is the main drawback of preferred stock compared to bonds?

Answer 18

Dividends on preferred stock are not tax-deductible; bond interest is.

Question 19

What is an Income Trust?

Answer 19

A fund structure investing in mature businesses, offering high returns and tax efficiency

Question 20

What are 3 uses of repurchased shares?

Answer 20

1) Reissue for employee stock plans 2) Reduce dilution 3) Defend against takeovers

Question 21

What are tender offers?

Answer 21

Offers to repurchase shares at a premium to shareholders, often in M&A scenarios

Question 22

What financial impact does a share repurchase have on ownership structure?

Answer 22

Reduces the number of shareholders, increasing ownership percentage of remaining holders

Question 23

How does repurchasing shares affect control in the firm?

Answer 23

increases control for insiders and long-term investors by concentrating ownership

Question 24

How does the market typically react to share repurchases?

Answer 24

Often positively, as it’s seen as a signal that management believes the stock is undervalued

Question 25

why might a company choose stock repurchase over dividend increase?

Answer 25

Repurchase is a one-time event; dividend increases create ongoing expectations

Question 26

What is signaling theory in relation to stock repurchases?

Answer 26

It suggests that management uses share buybacks to signal confidence that the stock is undervalued and future prospects are strong.

Question 27

: How do taxes affect investor preference between dividends and repurchases?

Answer 27

Capital gains (from repurchases) are often taxed at lower rates than dividends, making repurchases more attractive for some investors.

Question 28

What is the effect of repurchasing stock on Return on Equity (ROE)?

Answer 28

Reduces equity base → increases ROE (assuming net income stays the same), making the company appear more efficient.

Question 29

What happens to the debt-to-equity ratio after a stock repurchase using cash?

Answer 29

It increases, as equity decreases while debt stays constant — this may raise financial risk.

Question 30

Why might a company avoid increasing dividends permanently?

Answer 30

Because it sets future expectations — a dividend cut later can be seen negatively by investors.

Question 31

What’s the difference between open market repurchase and tender offer?

Answer 31

Open Market: gradual repurchase over time. Tender Offer: company offers to buy back shares at a premium in a short time frame.

Question 32

What is the "information content" of dividends?

Answer 32

hanges in dividends often convey management’s outlook on future earnings — increases are seen as good news, decreases as bad.

Question 33

What does it mean when a company has a “residual dividend policy”?

Answer 33

It pays dividends only after funding all profitable investment opportunities — dividends are based on leftover earnings.

Question 34

What is clientele effect in dividend policy?

Answer 34

Different investors prefer different dividend policies (e.g., retirees prefer regular dividends; young investors may prefer growth).

Question 35

What are fractional shares in a DRIP?

Answer 35

Portions of a share that investors can own — DRIPs allow investing dividends in small amounts, even if it’s not enough to buy a full share.

Question 36

What is a DRIP?

Answer 36

A DRIP (Dividend Reinvestment Plan) is a program that allows investors to automatically reinvest their cash dividends into more shares of the company’s stock, instead of receiving cash.