Pretend you are the CFO of a company that has paid a steady dividend for the pas

Question

Pretend you are the CFO of a company that has paid a steady dividend for the past forty years and your recently hired, brilliant, freshly minted UTA Finance graduate who managed to pass Advanced Business Financial Analysis sends you a text message on your mobile phone while you are in the middle of yoga class that reads: Dividends are irrelevant. Why don’t we quit paying them? On your way home from class and experiencing inner peace, you decide to prepare a response to your newest colleague, who many not know much about your company, but is well versed in theory. The CFO, having rejected the idea of the company going private, believes that a large share repurchase program funded by issuing long-term debt would please the shareholders and raise the stock price. Impressed with the vast knowledge of corporate finance exhibited by the brilliant freshly mined UTA Finance graduate, the CFO asks the graduate for her opinion on the share repurchase idea. Overconfident about her ability to criticize the CFO the brilliant graduate does not believe it is a good idea. What are her arguments?

Explanation / Answer

Companies buy back the shares typically when the share prices are low. However, this is not a great step for individual investors.

1. Though the idea is to buy back the shares when the share price is low, this doesn't always happen. The company might purchase at higher levels and make a loss.

2. Sometimes companies buy back shares and cut out the dividend that must be paid. This is bad for an individual investor.

3. This might result in poor usage of capital. The capital used to repurchase the shares can be invested for the growth of the company.

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