CFA CFA Level 2 Share Repurchase Impact on Financial Leverage

Share Repurchase Impact on Financial Leverage

  • This topic has 3 replies, 2 voices, and was last updated Aug-17 by vincentt.
  • Author
    Posts
  • STP
    Participant
    Up
    22
    Down

    Hello!

    I’m reading up on the choice between paying cash dividends and repurchasing shares (LOS 27.g), and I’m struggling to understand how share repurchases increase financial leverage. What I do understand is why a company would repurchase shares – in order to achieve or move in the direction of optimal capital structure.

    Would anyone mind to help explain the “how” reasoning I’m unable to think through?

    vincentt
    Participant
    Up
    4
    Down

    Formula for Financial Leverage = total debt / equity

    Equity = outstanding shares

    So when a company buy back shares it reduces the equity (the denominator) which will increase the financial leverage.

    e.g. Debt = 10m; Equity = 5m;
    Financial Leverage = 10/5 = 2

    Company buyback 3m
    Financial Leverage = 10 / (5 – 3) = 5

    STP
    Participant
    Up
    4
    Down

    Boy, that was easy! Thanks, vincentt.

    vincentt
    Participant
    Up
    2
    Down

    no problem STP!

Viewing 4 posts - 1 through 4 (of 4 total)
  • You must be logged in to reply to this topic.