Question

What are some of the reasons that management purchases its own stock? b. Explain how earnings per share might be affected by treasury stock transactions. c. Calculate the debt to assets ratio for the current year and the prior year, and discuss the implications of the change.

Answer 1

Management buys back its own stock for various strategic reasons, which can improve earnings per share by reducing shares outstanding. The debt to assets ratio indicates financial leverage and changes in the ratio have implications for a company's financial health.

Step-by-step explanation:

Management may purchase its own stock for several reasons, such as to signal confidence in the company, to attempt to increase the stock price by reducing the number of shares available, or to have shares available for employee compensation plans. Additionally, purchasing treasury stock can impact the earnings per share (EPS) because it reduces the number of shares outstanding, which can increase the EPS if net income remains constant or grows.

The debt to assets ratio measures the proportion of a company's assets that are financed by debt. To calculate it for the current and prior year, take the total debt and divide it by the total assets for each year respectively. A decreasing ratio suggests that a company is becoming less reliant on borrowing, which could indicate improved financial health, while an increasing ratio may suggest the opposite. However, the interpretation of these changes depends on the context of the company's overall financial strategy and industry norms.

Answer 2

a) first of all, in order for a company to repurchase their stock they must have extra cash available that will not be used for financing either existing or future projects. Also, corporations tend to repurchase stocks when they believe that their market price is too low (or lower than their own calculations). When corporations start to repurchase stocks, generally the market price tends to increase.

b) since treasury stocks decrease the company's total outstanding stocks, the earnings per share will increase. EPS = (net income - preferred dividends) / weighted average outstanding common stocks. If the denominator decreases, then the total result should increase.

c) the information is missing, so there is no way to calculate the debt to assets ratio. But if we analyze the formula:

debt to assets ratio = total debt / total assets

when equity decreases (treasury stocks decrease equity), total assets will also decrease, but debt remains the same. Therefore, an increase in treasury stocks will result in a higher debt to assets ratio which means that the company's risk is higher than before.