Question
DRK Corporation announced to repurchase its stocks. How will DRK's stock price change and why? (2) If a majority of the shareholders have better investment
DRK Corporation announced to repurchase its stocks. How will DRK's stock price change and why?
(2) If a majority of the shareholders have better investment opportunities than the firm, do you think that they favor a low dividend policy or a high dividend policy? Why?
Step by Step Solution
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1 Impact of Stock Repurchase on DRKs Stock Price When a company announces a stock repurchase program it typically has a positive impact on the companys stock price There are a few reasons for this 1 Signaling Effect A stock repurchase program signals to the market that the companys management believes the stock is undervalued This conveys a positive message about the companys prospects and can increase investor confidence leading to higher demand for the stock and a subsequent increase in the stock price 2 Reduction in Supply When a company buys back its own shares the number of shares outstanding in the market decreases This reduction in supply of the companys shares can lead to an increase in the stock price as the same level of demand is now spread across a smaller number of shares 3 Improved Financial Metrics Stock repurchases can improve the companys financial metrics such as earnings per share EPS and return on equity ROE by reducing the number of outstanding shares These improvements can make the companys stock more attractive to investors and contribute to an increase in the stock price Therefore the announcement of a stock repurchase program by DRK Corporation is likely to have a positive impact on the companys stock price as it signals the managements confidence in the companys future prospects and leads to a reduction in the supply of DRK shares in the market 2 Dividend Policy Preference for Shareholders with Better Investment Opportunities If a majority of DRK Corporations shareholders have better investment opportunities than the firm they would likely favor a low dividend policy rather than a high dividend policy The rationale behind this is as follows 1 Opportunity Cost Shareholders with better investment opportunities outside the firm would prefer to retain the companys earnings and reinvest them in their own higheryielding investments rather than receiving dividends Receiving dividends would mean forgoing the potentially higher returns from their own external investment opportunities 2 Efficient Capital Allocation Shareholders with better investment opportunities are likely to believe that they can allocate capital more efficiently than the companys management They would prefer the company ...
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Fundamentals of Financial Management
Authors: Eugene F. Brigham, Joel F. Houston
Concise 6th Edition
324664559, 978-0324664553
