Analysis of Dividends and Share Repurchases

Correct Answer: The share price should increase as the higher dividend signals management's confidence in the company's future earnings potential.

The correct answer is that the share price should increase as the higher dividend signals management's confidence in the company's future earnings potential. When a company increases its dividends, it sends a positive signal to the market about its future prospects. Higher dividends suggest that the company expects to generate sufficient cash flows to sustain the increased payouts, indicating confidence in its ability to maintain or grow its earnings. The other two options are incorrect: The share price should not decrease because, although higher dividends may reduce retained earnings in the short term, the positive signal about future earnings potential outweighs this concern. Investors view the increased dividends as a sign of financial strength and stability. The share price is unlikely to remain unchanged because the market will react to the new information provided by the dividend increase. The historical dividend policy and current financial position are already priced in, but the dividend increase provides additional positive information that will likely lead to a higher share price.

Correct Answer: Share repurchases reduce total equity, which increases the return on equity (ROE) ratio.

The correct answer is that share repurchases reduce total equity, which increases the return on equity (ROE) ratio. Share repurchases involve a company buying back its own shares from the market, which reduces the total number of outstanding shares and the total equity on the balance sheet. As a result, the ROE ratio, calculated as net income divided by total equity, will increase because the denominator (total equity) decreases while the numerator (net income) remains unchanged. The other statements are incorrect: - Share repurchases decrease, not increase, the number of outstanding shares. This would typically lead to an increase in earnings per share (EPS), not a decrease, as the net income is divided by a smaller number of shares. - While share repurchases do decrease the company's cash balance, this would actually weaken the current ratio (current assets / current liabilities) as cash is a current asset. Reduced cash could also limit financial flexibility, but this does not improve the current ratio.

Correct Answer: The company's share price is likely to increase due to the increased demand for the stock and the signal of management's confidence in the company's future prospects.

When a company announces a share repurchase program, it signals to the market that the management believes the company's shares are undervalued. By buying back its own shares, the company creates additional demand for the stock, which can drive up the share price in the short term. Furthermore, a share repurchase program reduces the number of outstanding shares, which can increase the earnings per share (EPS) and make the company's financial ratios look more attractive to investors. The other two options are less likely: - A decrease in share price due to the perception of lacking profitable investment opportunities is unlikely, as the company is using its cash to invest in its own shares, which it believes are undervalued. - The market may not have fully priced in the impact of the share repurchase announcement, as the actual execution of the program can take place over an extended period, and the market sentiment may change during this time.