DIVIDENDS VERSUS TREASURY STOCK PURCHASES



DIVIDENDS VERSUS TREASURY STOCK PURCHASES

Assume that Carter Corporation has 1 million shares outstanding and has three shareholders, i, j and k owning 30%, 30% and 40% of the company(s stock, respectively; thus, i owns 300,000 shares, j owns 300,000 shares and k owns 400,000 shares. The market value of Carter(s assets (as a going concern), liabilities and equity are, respectively, $140 million, $40 million, and $100 million (company value of $140 million less liabilities of $40 million,). Assume that among Carter’s assets is $15 million in cash. Since there are 100 million shares outstanding, the market price per share of Carter common stock is $100 ($100 million equity value/1 million shares).

Carter will pay out $10 million to shareholders. Compare three cases: (a) Carter pays out $10 million in dividends; (b) Carter buys back $10 million of its shares on a pro rata basis. (c) Carter buys back $10 million of i’s shares and none of the shares of j and k. These cases are shown in exhibit on page 3.

First, let’s compare cases (a) and (b). In case (a), Carter pays out $10 million in dividends; shareholders i and j each receive $3 million, and k receives $4 million. In case (b), Carter buys back 30,000 shares, or $3 million worth, of each of i(s and j(s stock, and buys back 40,000 shares, or $4 million worth, of k(s stock. In both cases (a) and (b), as a result of the $10 million cash payout, Carter’s assets fall to $130 million, its liabilities remain at $40 million, and its equity value declines to $90 million. Notice from the data in Exhibit I that a shareholder has the same amount of cash and the same equity value with the treasury stock purchase as with the dividend. For example, with a dividend shareholder i gets $3 million in dividends and has shares worth $27 million after the dividend; and, with a treasury stock purchase, i gets $3 million in cash from selling back shares to the company and has shares worth $27 million after share repurchase.

Even in the usual case in which a share repurchase is not on a pro rata basis, the firm(s shareholders in the aggregate receive the cash payments from the company for the repurchased shares, and this cash payment is part of the period(s cash flow to stockholders. For example, imagine case (c) in which, instead of case (b) above in which the same percentage of each shareholder’s stock was repurchased (pro rata repurchase), Carter Company repurchases $10 million of i(s stock and none of j(s or k(s stock. The total cash payout of $10 million would all go to i. This is described in Exhibit I.

Notice that the fraction of the equity owned by i has fallen from 30 percent to 2/9ths, whereas the fractions owned by j and k have risen from 30 percent to 3/9ths and from 40 percent to 4/9ths, respectively. The value of the shares owned by j and k has not changed because the payout of $10 million of cash has reduced the total equity value from $100 million to $90 million.

6/24/2005

Exhibit: Alternative Cash Payout Methods

(a) Dividend of $10 million

| |Before Dividend |After Dividend |

|Assets |$140 mil. |$130 mil. |

|Liabilities |$ 40 mil. |$40 mil. |

|Equity |$100 mil. |$90 mil. |

|Number of shares outstanding |1 mil. |1 mil. |

|Price per share |$100 |$90 |

| |Dividend |Equity owned after dividend |Share value |Dividend plus |

| | | |after dividend |share value |

|i |$3 mil. |300,000 shares or 30% |$27 mil. |$30 mil. |

|j |$3 mil. |300,000 shares or 30% |$27 mil. |$30 mil. |

|k |$4 mil. |400,000 shares or 40% |$36 mil. |$40 mil. |

(b) Pro rata repurchase (treasury stock) of 100,000 shares worth $10 million

| |Before stock repurchase |After stock repurchase |

|Assets |$140 mil. |$130 mil. |

|Liabilities |$ 40 mil. |$40 mil. |

|Equity |$100 mil. |$90 mil. |

|Number of shares outstanding |1 mil. |900,000 |

|Price per share |$100 |$100 |

| |Value of shares sold |Equity owned after repurchase |Share value |Repurchase proceeds |

| |to company | |after repurchase |plus share value |

|i |$3 mil. (30,000 shares) worth $3 |270,000 shares or 30% |$27 mil. |$30 mil. |

| |mil. | | | |

|j |$3 mil. (30,000 shares) worth $3 |270,000 shares or 30% |$27 mil. |$30 mil. |

| |mil. | | | |

|k |$4 mil. (40,000 shares) worth $3 |360,000 shares or 40% |$36 mil. |$40 mil. |

| |mil. | | | |

(c) Disproportionate repurchase (treasury stock) of 100,000 shares worth $10 million

| |BEFORE STOCK REPURCHASE |AFTER STOCK REPURCHASE |

|ASSETS |$140 MIL. |$130 MIL. |

|LIABILITIES |$40 MIL. |$40 MIL. |

|EQUITY |$100 MIL. |$90 MIL. |

|NUMBER OF SHARES OUTSTANDING |1 MIL. |900,000 |

|PRICE PER SHARE |$100 |$100 |

| |Value of shares sold to company |Equity owned after repurchase |Share value after |Repurchase proceeds plus share |

| | | |repurchase |value |

|i |$10 mil. (100,000 shares) |200,000 shares or 2/9 |$20 mil. |$30 mil. |

|J |none |300,000 shares or 3/9 |$30 mil. |$30 mil. |

|k |none |400,000 shares or 4/9 |$40 mil. |$40 mil. |

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