Question

Biscayne Bay Water Inc. bottles and distributes spring water. On May 14 of the current year, Biscayne Bay Water Inc. reacquired 2,700 shares of its common stock at $59 per share. On September 6, Biscayne Bay Water Inc. sold 2,200 of the reacquired shares at $62 per share. The remaining 500 shares were sold at $55 per share on November 30.

a. For what reasons might Biscayne Bay Water Inc. have purchased the treasury stock?

Answer 1

There are different reasons of buy back of own shares [Treasury stock ] and these are (1) To make increment in market price of shares, (2) Potential increment in EPS, (3) elimination of ownership interest of stockholders, (4) To meet additional stock needs for stock dividends etc.

But here, in this case the reason is quite different. Here, company purchased treasury stock with a clear  intention to resale it at a profit and build strong financial base reflected by paid in capital - treasury stock in the balance sheet .

Total amount of cash out flows for buyback of own shares (treasury stock) = 2,700 X $ 59 = $ 159,300

Cash inflow when resale of treasury stock made in September = 2,200 X $ 62 = $ 136,400

Net gain in September on resale of treasury stock , transferred to paid in capital - treasury stock = $ 136,400 - [ 2,200 X $ 59] = $ 136,400 - $ 129,800 = $ 6,600

But then after due to market fluctuations or any different reasons ( More availability of outstanding common stock ) outstanding stock price decreases and it was too risky for the firm to hold the remaining treasury stock at $ 59 each. After observing a downward trend of stock price , treasury stock are being sold at loss of $ 4 each [ $ 59 - $ 55]

Total cash inflows in November for resale of treasury stock = 500 X $ 55 = $ 27,500

Loss on resale of treasury stock on November = 500 X $ 4 = $ 2,000 which ultimately reduces the paid in capital - treasury stock to [ $ 6,600 - $ 2,000] = $ 4,600.

In conclusion, it must be said that the purpose of buyback of own shares ( treasury stock ) is partially accomplished.