Question

Is it reasonable to conclude from reading the article that firms would achieve higher TSR by making acquisitions or stockpiling cash? Why or why not? What additional information would you need to properly assess the impact on shareholder wealth of the various capital deployment choices described in the article?

Answer 1

Note: The article has not been shared in the question, therefore the question is being answered based on the general concept of impact of capital decisions on TSR.

Solution:-

When a stock is valued in the market, its valuation depends upon the ability of the company's business to generate returns on equity. Here we must observe that excess cash lying on the balance sheet without any specific purpose is is an asset that earns just the risk free rate of return and not high risk-exposed returns that an investor expects to earn from a business.

This is why the cash lying on the balance sheet is deducted while calculating the enterprise value as it carries no risk and has no enterprise value.

This is the reason that management is always under pressure from shareholders to deploy cash whenever it has high sums piled up on its balance sheet. In simple words, an investor can himself invest in risk free interest earning assets, so why would they want to pay for that in the form of higher stock price. They invest in shares to invest in the business related operating assets and not the non-operating assets. Therefore, while investors always prefer the management appropriately deploys cash, the following points are important and must be considered:

• Good levels of cash are considered important in certain industries that change a lot like technology as it gives companies muscle power to maintain their positions in the market
• Very high levels of cash are highly discouraged by shareholders as it reduces the TSR with cash earning only basic interest and not deployed in business
• The acquisitions should be carefully made and the companies must not overpay just because they have excess cash