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Explain why Share buy-backs are seen as an attractive way of altering a company’s capital structure and examine the circumstances in which they can ‘ensure appropriate share prices’.

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Introduction

Explain why Share buy-backs are seen as an attractive way of altering a company's capital structure and examine the circumstances in which they can 'ensure appropriate share prices'. For one to own a company's shares is to stake claim to the firm's earnings. Any enterprise that possesses capital in excess of its requirements (or earns profits) must necessitate one or more of a combination of possible 'Capital Management Policies.' Primarily, it may choose to retain and plough back these funds internally in order to expand potential operations such as the purchasing of other businesses, buying capital assets*, improving existing operating conditions within the firm etc.; secondly, it could return them to shareholders on a proportional basis in the form of dividends; and/or finally, by share 'buy-back' where the company can return capital to those owners who prefer to exchange their shares for cash.1 If the company does choose to drive the share buyback highway, UK companies for instance could repurchase shares via: (a) Purchasing shares from the stock market; (b) Arrangements with individual shareholders; (c) Tender offers to all shareholders. Changes in corporation laws in recent years2 in many different countries, especially in the last 6-7 years has made the process of companies to repurchase their own shares more accessible so in consequence the volume and value of transaction activity in repurchases has risen dramatically, ...read more.

Middle

* Assume that it has �100 of capital, which is surplus to requirements - cannot be put it to good use within the company and will therefore be returned to shareholders. * The company's book value is �1 per share [�1000/1000 shares] = E.P.S. which earnings per share are �0.10. Return on shareholders' equity (R.O.E.) is 10%. [�100/�1000]. * Finally, perhaps assume the company shares market price is �1 (i.e., ten times the E.P.S.) and that every shareholder has bought his or her shares at this price. If the company distributes its excess capital in the form of a dividend, then the dividend is �0.10 per share and all shareholders earn 10% (�0.10/�1.00) on their investment. If in the following year it again earns �10, then E.P.S., ROE and book value will remain exactly as mentioned above. If, however, the firm uses the �100 of excess capital to repurchase 100 of its own shares at the prevailing market price, then those who sell into the buyback receive, �1 per share. The company then would cancel the repurchased shares so its capital structure shrinks to 900 shares and �900 of shareholders' equity. Book value remains �900/900 shares or �1 per share. If, say in the next year the company again earns �100, then E.P.S. ...read more.

Conclusion

During the period of sustained share price, positive news on companies share prices emulates aiding the image and perception of the enterprise in shareholders eyes. It is worth mentioning here too that not all proposed share re-purchasing is seen through to the end; merely rumours are proliferate, effectively 'deceiving' in my opinion, the shareholders****. Indeed, one of the trends these days is for some companies to use this 'signalling effect' to raise share prices. Generally speaking, leverage increasing exchange offers have significant affirmative announcement effects, where debt-to-debt exchanges in shares have no relevant effect on shareholders wealth an leveraged decreasing exchange offers have a significant depressing effect (Dietrich 1984). Further, these points place into context the results of a study, published in, of buybacks undertaken in the U.S. during 1999. It listed the 50 companies in the Standard & Poor's 500 which repurchased the biggest percentage of their shares. The market price increases of only 8 of the 50 exceeded that of the S&P. Indeed, the prices of 33 of the 50 decreased and their weak results had continued into 2000. There can be further reasoning behind this however (report from CS First Boston, who compiled the data), with an offered explanation with many companies last year, big buybacks were more a reaction to some sort of distress than any portent of success. ?? ?? ?? ?? 1 Corporate Finance and Derivative Products. 2001 Assessment Essay_________________________________________________________Arpita Khanna ...read more.

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