Question

Stock repurchases

There are a number of reasons why a firm might want to repurchase its own stock. Read the statement and then answer the corresponding question about the company’s motivation for the stock repurchase:

Happy Orange Storage Company’s board of directors has decided to repurchase some of its stock on the open market because it wants to increase the company’s debt-to-equity ratio.

What is the company’s motivation for the stock repurchase?

To adjust the firm’s capital structure

To acquire shares needed for employee options or compensation

To distribute excess funds to stockholders

To protect against a takeover attempt

Which of the following statements would be considered advantages of a stock repurchase? Check all that apply.

The market generally perceives a stock repurchase as a sign that management believes that the firm’s stock is undervalued.

Stock repurchases allow a firm to distribute earnings to investors without changing the amount of the regular cash dividend.

At times, the company will repurchase its stock at a price higher than the true value of the stock.

Answer 1

To adjust the firm's capital structure

It is given that the company wants to repurchase stock in order to increase its debt to equity ratio which represents the company's capital structure.

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The market generally perceives a stock repurchase as a sign that management believes that the firm’s stock is undervalued.

Stock repurchases allow a firm to distribute earnings to investors without changing the amount of the regular cash dividend.

Both the above statements can be perceived as advantages of a stock repurchase. Companies generally buy back their own shares when they feel it is undervalued in order to profit from the expectation of a future price correction. Also, stock repurchases allow firms to pay their investors without altering the amount of dividend payments.