Final answer:
A share repurchase is equivalent to a cash dividend in that both provide a return to shareholders. It reduces the number of outstanding shares and can lead to capital gains for shareholders, similar to receiving a direct payment from dividends.
Step-by-step explanation:
A share repurchase is said to be equivalent to the payment of a cash dividend because each strategy effectively returns money to shareholders. When a company repurchases its own shares, it reduces the number of shares outstanding, which can increase the value of remaining shares. This increase in value can be seen as a capital gain for the shareholders, similar to the direct payment received from a dividend. Investors expect a return on their investment either through dividend payments or by selling their shares at a higher price than what they paid, realizing a capital gain.
As an example, if an investor bought a share of stock in Wal-Mart for $45 and later sold it for $60, the $15 increase in the value of the stock represents a capital gain. Comparatively, should a firm choose to distribute cash via dividends, the investor receives a direct payment, often based on the percentage of the profits the company decides to distribute to its shareholders.