PLEASE PROVIDE A COMPLETE WRITTEN ANSWER Kellogg Company is the world’s leading
ID: 2424971 • Letter: P
Question
PLEASE PROVIDE A COMPLETE WRITTEN ANSWER
Kellogg Company is the world’s leading producer of ready-to-eat cereal products. In recent years, the company has taken numerous steps aimed at improving its profitability and earnings per share. Presented below are some basic facts for Kellogg.
What are some of the reasons that management purchases its own stock?
Explain how earnings per share might be affected by treasury stock transactions.
Discuss the implications of the change by calculating the ratio of debt of assets for 2010 and 2011.
2011 2010 Net sales $13,198 $12,397 Net income 1,229 1,240 Total assets 11,901 11,847 Total liabilities 10,139 9,693 Common stock, $0.25 par value 105 105 Capital in excess of par value 522 495 Retained earnings 6,721 6,122 Treasury stock, at cost 3,130 2,650 Number of shares outstanding (in millions) 357 366Explanation / Answer
(a) Management might purchase treasury stock to provide to stockholders a tax-efficient method for receiving cash from the corporation. In addition, it might have to repurchase shares to have them available to issue to people exercising options to purchase stock, or management might purchase treasury stock because it feels that its stock price is too low. It may believe that by purchasing shares it is signaling to the market that the price is too low. Management might also use excess cash to purchase stock to ward off a hostile takeover. Finally, management might purchase stock in an effort to change its capital structure. If it purchases stock and issues debt (or at least does not retire debt), it will increase the percentage of debt in its capital structure
(b) Earnings per share is calculated by dividing net income by the weighted-average number of shares outstanding during the year.
If shares are reduced by treasury stock purchases, the denominator (weighted-average number of shares outstanding) is reduced. As a result, earnings per share is often increased. However, because corporate assets are reduced by the purchase of the treasury stock, earnings potential may decrease. If this occurs, the effect on earnings per share may be mitigated.
(c) One measure of solvency is the ratio of debt divided by total assets. This ratio shows how many dollars of assets are backing up each dollar of debt, should the company become financially troubled. For 2011 and 2010, this can be calculated as follows:
2011 : ($10,139 ÷ $11,901) = 0.85
2010 : ($9,693 ÷ $11,847) = 0.82
This represents a decrease in the ratio of debt to total assets. It may be determined that Kellogg’s solvency is weakening and should be watched. A debt to total assets ratio of .85% means that Kellogg is highly leveraged and that its financial flexibility may be weak.
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