Question

20.

Which of the following Statements is correct?

a. If a company uses the residual dividend model to determine its dividend payments, dividends payout will tend to increase whenever its profitable investment opportunities increase.

b. Large stock repurchases financed by debt tend to increase earnings per share, but they also increase the firm's financial risk.

c. The tax code encourages companies to pay dividends rather than retain earnings.

d. The stronger management thinks the clientele effect is, the more likely the firm is to adopt strict version of the residual dividend model.

e. A dollar paid out to repurchase stock is taxed at the same rate as dollar paid out in dividends. Thus, both companies and investors are indifferent between distributing cash through dividends and stock repurchase programs.

 

21

Which of the following statements is correct?

a. stock repurchases tend to reduce financial leverage.

Answer 1

q. 20 Large stock repurchases financed by debt tend to increase earnings per share, but they also increases firm’s financial risk.

Capital markets are not perfect and shareholders are not indifferent between dividends and retained earnings. Because of the market imperfections and uncertainty, shareholders may prefer the near dividends to the future dividends and capital gains. The payments of dividends may significantly affect the market price of the share.

.If the firm raises debt the financial obligations and risk will increase.

A stock repurchase may be viewed as an alternative to paying dividends in that it is another method of returning cash to investors. A stock repurchase occurs when a company asks stockholders to tender their shares for repurchase by the company

a stock repurchase can increase value for stockholders. A repurchase can be used to restructure the company's capital structure without increasing the company's debt load.

a company changing its dividend policy, it can offer value to its stockholders through stock repurchases, keeping in mind that capital gains taxes are lower than taxes on dividends.

A repurchase of a significant amount of shares through the use of debt financing is called leverage buy back. .A company may undertake a leveraged buyback in order to raise share prices (if a partial buyback), to avoid over-capitalization, to take a public company private or to protect a company from a hostile takeover.

Q21. Answer is

If a firm repurchases some of its stocks in the open market then shareholders who sell their stock for more than they paid for it will be subject to capital gain taxes .

The buy back of shares is the repurchase of its own shares by a company. The most plausible reason for the buyback seems to be that a company may like to return surplus cash which it can not put to any profitable investment to shareholders. Companies may also like to use surplus cash to buy back shares rather than pay large dividends which they can not maintain in the future years. In those countries where dividends are taxed at a higher rate than the capital gains, companies may like to resort to shares buyback from time to time to reduce the shareholders tax burden.