Question

Explain how cash dividends affect individual shareholders differently than an equal amount of funds spent on a repurchase.

Answer 1

Cash dividend declared:

In this case, Shareholders get the cash dividend as income and the share price reduces by same amount of dividend declared per share. So, net no gain or loss to individual shareholders as per 'Modigliani and Miller' approch.

Buyback of Shares:

In this case, company buy back its own shares from the existing shareholders. So, shareholders get the amount equal to share price on the date of buy back. And number of oustanding shares of company reduces because of buyback so, share price reduces to such extent.