Question

Discuss how a stock repurchase acts like a cash dividend and the tax advantages provided by the stock repurchase.

Answer 1

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. There are several reasons why a stock repurchase can increase value for stockholders. First, a repurchase can be used to restructure the company's capital structure without increasing the company's debt load. Additionally, rather than 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.

Share repurchases are a more tax efficient way to return capital to shareholders because there is no additional tax on buybacks even though your pro-rata equity in the enterprise increases, resulting in potentially more profit and cash dividends on your shares even if overall sales or profits never increase.