Cash Dividends Vs. Share Repurchase

Market value: $20 per share

Company profits: $5 million

Profits distributed: $1 million

The company has two alternatives:

Pay cash dividends at $1 per share

Repurchase stock equivalent to $1 million

Let's calculate the impact of wealth in both cases.

Cash Dividends

After the dividends are paid, the ex-dividend price would be: $20 - $1 = $19 per share

This can also be calculated as follows:

= ((1 million shares * $20 per share) - $1 million dividends)/1 million shares

= $19 per share

So, the shareholder has a stock worth $19 and $1 in cash that he receives in the form of cash.

Total wealth for each share = $19 + $1 = $20

Share Repurchase

For $1 million, the company will purchase 1,000,000/20 = 50,000 shares. The share price after repurchase can be calculated as follows:

= ((1 million shares * $20 per share) - $1 million dividends)/(1 million shares - 50,000 shares)

= $19,000,000/950,000

= $20

Total wealth for each share  = $20

As you can see, in both cases the shareholder's wealth remains the same. So, practically, cash dividends have the same impact on shareholder's wealth as the share repurchase.