Question

The company has grown rapidly during the last 10 years of operations. As its segment of the industry has begun to mature, though, the fast growth of previous years has begun to slow. Assume that the last financial reporting (10k) shows revenues and profits that are roughly the same as previous year’s report. Further assume your group was the board members for the company. During your meeting, it was recommended that it is time for a share buyback program instead of issuing the bonds and using the funds for the expansion. One of your group members argued that you can always issue more bonds next year, but right now, you will need a quick fix for the EPS numbers. By now, the company’s shareholders are accustomed to increases every year. How are buyback of shares provide a “quick fix” for EPS? Would it be ethical for companies to implement share buybacks instead of expansion? Who would be affected if the proposal is implemented?

Answer 1

The buy back refers to the repurchase of shares by the issuing company.The buyback program is often implemented by a company for multiple reasons.With regard to EPS the buyback would result in an increase in Earnings per share.Earnings per share =income available to share holders/no :of shares outstanding.A buyback would result in lowering of the number of shares of the firm and as a result the EPS would increase.The buyback program would result in a boost to the various financial ratios of the firm.Other reasons to do a buy back would be to preserve the stock price and if the firm thinks if it's shares are undervalued.During a recession the buy back program would help a firm to preserve it's share price and make sure the impact is minimal.If the firm feels it's shares are undervalued, then a buy back would help them purchase their shares at a lower price and then re issue them when the market corrects itself.this would enable the fir to raise funds through equity without further dilution of ownership.

From an ethical perspective buybacks are often seen in a negative light.The critics of share buybacks argue that firm's engage in buybacks to escape their tax liabilities as buy backs are not taxed like dividends are.Another major criticism is that it's done in order to temporarily inflate the financial ratios of the firm.Most recently buybacks have been criticized stating they are done by firms to avoid investing in plant property or equipment expansion,and to avoid wage hikes.

Implementing a buyback would help the share holders of the firm by increasing the shareholder value and the share price. It would help the company to consolidate ownership as the number of shares outstanding decreases the ownership becomes more concentrated in the hands of the company.It would also help the firm by lowering the equity financing costs as the number of shares decreases due to buyback.