Question

1) Which of the following considerations should NOT be related to management's concerns when setting a stock repurchase policy?

A) Does a firm have enough financial reserves to meet the short-term obligations in periods when earnings are down or investment requirements are up?

B) Is the stock currently undervalued? Can the management add value to the company by initiating a stock repurchase?

C) Over the long term, how much does a company's level of earnings exceed its investment requirements? How certain is this level?

D) Can a firm quickly raise equity capital if necessary?

2) Which of the following statements about the relative advantages of stock repurchases over dividends is NOT true?

A) Open-market stock purchases allow management more flexibility because investors are less likely to react if the management cuts back or ends a stock repurchase as compared to cutting back on dividend payments.

B) Since most ongoing stock repurchase programs are as visible as dividend programs, they can be used effectively to send a positive signal about a firm’s prospects to investors.

C) Stock repurchases allow stockholders to choose whether or not to participate in the stock repurchase. This allows stockholders to have more control over their tax burden.

D) Historically, taxes on dividend payment have been higher than those on stock repurchases.   

Answer 1

(1) (B) Is the stock currently undervalued? Can the management add value to the company by initiating a stock purchase?

This will not be managements concern while deciding for stock repurchase apart from other options because if stock is undervalued, management can definitely add value by stock purchase. By doing this company can reduce the number of outstanding shares in the market which would have a positive impact on the EPS or Market price of the stock.

(2) (B) Since most ongoing stock repurchase program are as visible as dividend programs, they can effectively send a positive signal about firms situation to investors.

This is a false statement as stock repurchase many times have negative signals to investors than positive. Whereas dividends are always in favour of investors and more dividend also have a positive impact on return on investment.