Question

Why firms repurchase their own shares instead of paying excess cash as increased dividend? Explain.

Answer 1

Re purchase of shares is more beneficial than dividend distribution in many ways:

The main advantage of buy back is that it facilitates capital restructuring of company. By getting rid of capital not required by it, company is able to increase it,s earning per share. Suppose company has Total Assets of 20 lacks all financed with equity. And company has assets turnover ratio(Turnover/Total assets) of .5 (10 lack /20 lack). Means company has unutilized assets. Means its sale will not be affected if the assets are reduced by reducing the amount of capital through buyback. The same amount of profit is divided into less number of shares results into increased eps.

Secondly there is no additional tax on the buyback while on dividend there is levied a Dividend Distribution tax.

Therefore companies prefer repurchase of shares than buyback.