FIN 71 - Dividends vs Buybacks

Let's take a look at problem 13-2a, dividends versus share repurchases. So part one has us looking at dividends, part two is similar share repurchase, and then we're going to compare the two. Switch company has assets with market value of $600,000, so its assets are 600K. Because the company has no liabilities, liabilities are zero. Because there's no liabilities, its equity also is 600K, so there's sort of the balance sheet laid out, a very simple balance sheet. The company has 10,000 common shares, outstanding. Okay, so if we have 600 grand in equity and we have 10,000 shares, the price per share is going to be, what is that, 60, right, $60 per share. The company is considering declaring a dividend of $3 per share per day with a stock going ex-dividend tomorrow. Assume the company declares and pays the dividend as planned. What's the stock price today? Oh, we just did that, 60. What will be the stock price after the dividend? Okay, well, again, in a perfect world, right, where there's not other reasons for moves in stock price, like earnings or just news events or whatever might move a stock price, in a sort of theoretical world, what's happening here? Well, we have $600,000 in assets, but we're going to give away, not give away, but issue dividends of $30,000, so we go from 600 to 570 in assets. Our liabilities don't change and our equity, therefore, has to fall to 570. We still have 10,000 shares out there, but now we only have 570 grand in equity, meaning our stock price drops to 57 bucks. You could have also gone 60 minus three is 57. That's not how I think about it, though. What will be the change in assets and equity as a result of the dividend? Okay, so we've kind of done that as well. I'm jumping the gun on the problem, but our assets, when we pay a $30,000 dividend, well, it's cash, so our cash goes down by 30 grand, our assets go down by 30 grand, and our equity, therefore, necessarily also falls by $30,000. What will be the change in assets and equity? Both fall by 30K to 570, right? We were at 300, not 300, 600K, now we're at 570K. Okay, so assume instead of the dividend outlined in part one, the company uses that $30,000 and buys back shares. Lots of companies are buying back shares instead of paying dividends these days. Consider how this will affect the company's equity by answering the following. What's the new market value of the company's equity? Well, same balance sheet situations going on in scenario two as was happening in scenario one. Let me copy and paste this. Oh no, things have gone south, things have gone south. Microsoft OneNote sometimes does wacky things, although I think that one was my fault. What's happened with the balance sheet is exactly the same. We add $600,000 in assets, we're paying $30,000 to buy back shares, so we're giving shareholders $30,000 of our cash, and we're taking their shares back and cancelling those shares, or yeah, essentially cancelling those shares, but in terms of a balance sheet, our assets go down by 30, our equity goes down by 30. What is the new market value of the company's equity? 570, right? We have $30,000 less of assets, therefore $30,000 less of equity. How many shares are we buying back? Well, let's see. How many shares did we have? 10,000 shares. Okay, let's do some math here. Our company before this, our company's market value was 600,000 divided by, oh, I did this already, 10,000 shares, and that is $60 per share. How many shares can we buy back for $30,000? Well, $30,000 divided by $60 a share, it looks like we can buy back 5,000 shares, right? 30,000 divided by 60, oh, 500 shares. I was way off. 500 shares get bought back. Okay, so how many shares will be repurchased? 500. Well, I had 10,000, I bought back 500. How many do I have now? 9,500. How many shares will be outstanding after this? 9,500. What's the new price per share? Well, let's do some calculating here. Our company value, our equity value is 570,000. We now have 9,500 shares out in the world, so 570 divided by 9,500 is $60 a share. The share buyback should not affect the stock price. There we have it. We've solved the ... Now it says, explain the key differences and similarities between the repurchase and the dividend. Repurchase from part two, which we just did, and the dividend from part one. Our dividend, before the dividend, our shareholders had $60 ... Let's do this in the blank screen. Before the dividend, our shareholders had a $60 in value, and what happened was the stock price after the dividend dropped to 57, but they got $3 cash, so again, old stock price, new price, cash, so they're in the exact same spot. With the buyback, before the buyback, the stock price was $60. After the buyback, the stock price is still $60, although some percentage of our shareholders have accepted $60 cash, so some of our shareholders have $60 worth of stock. Some of our stock, S-T-O-K, S-T-O-C-K, some of our shareholders have $60 worth of cash. In either scenario, our shareholders have $60 in value, and they're in the exact same position they were in before. Why would one do a buyback over a dividend? The reality is there are tax reasons for it that just aren't explored in this course. If you pursue your finance or accounting career further, that will be something that will certainly be covered, but in intro class, that's the reason buybacks have become much more popular. They're just tax advantages. Shareholders can decide whether they want to participate in the buyback or not, so they can decide if they want to trigger a tax event or not. A dividend simply triggers a tax event for the shareholder, and so not everybody wants that, so there are some advantages to buybacks. Let's leave it at that. It's a complicated subject that goes over my head at times as well, but I hope this video helped, and if it did, I hope you'll hit one of those buttons for me. Thanks for watching. Bye-bye.