Cash Dividends Vs. Share Repurchase

Both the cash dividends and share repurchase of same value have equivalent effect on the wealth of the shareholders. This assumes that all other factors such as the taxation are the same.

Let's take an example to understand this. Assume a company with the following information:

Shares outstanding: 1 million

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.

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