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Case Study
You are the Chief Financial Officer (CFO) of a listed Australian public company contemplating a share buy-back in the next six months. The CEO of the company is asking you to have a close look at the current half-year report due to be published shortly before the proposed share buy-back announcement.
You know there are several methods of reducing the current half-year profits, such as deferring sales to the next half-year period or bringing forward expenses from the next half-year period, which may cause the share price to fall prior to the share buy-back announcement. You also know that you can structure the buy-back in such a way that the majority of the cash paid is allocated to dividends that will absorb unused franking credits. Using this approach, a small amount would also be allocated to capital repayment, giving shareholders a capital loss for tax purposes so that the buy-back can be targeted at a price that is a discount on the prevailing market price.
Adapted from Gitman et al 6th edition, p 557.
Questions
1. Assuming that all ordinary shareholders of the company will have equal access to the proposed buy-back, briefly outline the regulatory requirements that must be followed by the company. What is the purpose of these measures? ( Maximum 100 words)
2. Explain why the company may want the share price to fall before the buy-back announcement. Discuss the suggested methods of reducing the half-year profit. In your discussion , consider the legal implications (including compliance with accounting standards) as well as the ethical implications. (Maximum 400 words)
3. Explain what is meant by “ allocating the majority of the cash paid to dividends”. What are the advantages (if any) of this strategy for the company? What are the advantages (if any) of this strategy for the shareholder? (Maximum 200 words)
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