Question

Write a one-page short essay on ONE of these topics:
H3.1 Many large companies have been buying back shares in recent years. What are the consequences of this for the company’s balance sheet? What does it mean for shareholders?

H3.2 There has been a lot of discussion about the inversion of the yield curve this year. What is the significance of this?

Answer 1

Buying back of shares simply refers to a public traded company purchasing its own shares from the share market. To give positive earnings to shareholders per share, or to increase the value of the stock, company use this method of buying back. Buying back reduces the number of shares outstanding in the market and effects cash flow in the balance sheet.

A share repurchase can lead the investors to think that the business has sufficient cash flow in case of emergency and a low probability of economic loss. There could be many reasons of buybacking the shares. Firstly, company wants to invest in themselves as buyback provide investors to have greater earnings per share, increase in stock price if same price to earnings ratio is maintained. Secondly, if company wants to retain existing shareholders, it repurchase its shares and give to its employees as an award. In the esaay, we can about differnt ratios pertaining to buy back like measures of profitability such as earnings per share, market capitalization ratio and cash flow per share.

Stating an example using hypothetical data will definitely work. Like a company named Biomill have 100 millions shares outstanding at the beginning of the year. The stock was trading at $10, making market capitalization of $1billion(100million*$10). Biomill have net income of $50 million. Earnings per share will be 50 cents( $50 million/100 million shares). Now assume biomill has $100 millions excess cash which it deployed in repurchse of share over next 12 months. left cash is $90 millions. Assume average cost of $10 each was repurchasing cost, which means total of $10 millions have repurchased. Suppose biomill has $50 millions net income also this year, this will increase earnings per share to 56 cents($50 million/90 million shares).Thus, buybacking of shares lead to increase in earnings per share.

Now, buybacking will imapct the financial statement as company has reduced its outstanding shares. To purchse its own shares, company has paid for them, so a reduction in cash flow will impact the assets base by the amount paid for repurchasing them. As we know, balance sheet has double entry for every transaction happened. So on liability side, it will impact shareholders's equity holdings by the same amount. As a result, performance will improve. Comapny's performance can be seen by return on equity and return on assets ratio.

After a buyback, there is less equity in the company, but there are also fewer shareholders with a claim on that equity. In fact, by reducing the supply of company stock available in the market, buybacks tend to push share prices up, which leaves the remaining shareholders with stock that's more valuable than before.hence, Return on equity improves. Return on equity helps investors to judge comapny how their investments are generating income.

Also, return on assets is proportion of net income to total value of assets in a given period of time. As assets have shrinked , denominator is reduced as comapre to numerator of net income, this shows return on assets have increased. Return on assets measure how management is using its assets base andother sources to generate income.

I hope this will be heplful to frame an essay.