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In option B...

  1. does the company sell the shares at $100 or at $106? Wouldn't it be selling 56600 shares at $106 rather than 60000 shares at $100? That would leave 943400 shares valued at $106. In your calculation the share buyback results in a +$0.38 bump to the share price, which seems inconsistent.

  2. aren't the assumptions about performance in the next year supposed to be factored in the share price already? [constant earnings per share is indeed a necessary assumption]

In any case, it seems share buybacks are "better" than dividends because the shareholders do not have to implicitly pay any tax on the company's profit: they get $6M as opposed to $4M.

If corporations pay tax only on profit, does this mean that they can use share buybacks to pay no tax at all?

Those whom the Gods wish to destroy They first make mad. -- Euripides

by Migeru (migeru at eurotrib dot com) on Sat Dec 23rd, 2006 at 06:06:14 AM EST
[ Parent ]
My model is not good enough for this level of accuracy (as I said) and is indeed not consistent.

Since you can't buy groceries with your shares, the shareholder wil have to sell, when he sells he will pay capital gain tax (or income tax), which can be more than company profit taxes.

If you bought at 100 and sold at 106, you make 6 in additional income which is taxed. If you hold on your share longer, you need to take into account risk-free interest rate, etc...

I don't know if retirement funds are taxed on capital gain, if not, we now know why they vote for share buybacks.

by Laurent GUERBY on Sat Dec 23rd, 2006 at 06:36:45 AM EST
[ Parent ]
Retirement funds can be legally organized, in the US, in so many ways a general answer is impossible.  

But, if your ready for this one, the US goverment, in its wisdom, allows corporations to put their own stock in their internal retirement plan.  So when they buy back shares they also increase the estimated net worth of that  fund as well.  

She believed in nothing; only her skepticism kept her from being an atheist. -- Jean-Paul Sartre

by ATinNM on Sat Dec 23rd, 2006 at 12:36:09 PM EST
[ Parent ]
The risk-free interest rate doesn't exist...

Those whom the Gods wish to destroy They first make mad. -- Euripides
by Migeru (migeru at eurotrib dot com) on Sat Dec 23rd, 2006 at 05:14:52 PM EST
[ Parent ]
Well, let's call it the best approximation of it and forget about the approximation :).
by Laurent GUERBY on Sat Dec 23rd, 2006 at 06:12:57 PM EST
[ Parent ]
I have a serious point to make with that, and that is that the assumption that there is a single lowest interest rate at which it is possible to both lend and borrow is simply not true. Well, it might be true for banks (i.e., market makers), for instance in London they can all borrow from each other at LIBOR, but other market participants don't have access to that, and can borrow and lend at different rates.

Those whom the Gods wish to destroy They first make mad. -- Euripides
by Migeru (migeru at eurotrib dot com) on Sat Dec 23rd, 2006 at 06:17:41 PM EST
[ Parent ]
The risk free rate is when someone lends to the state, and in France at least you can buy various "BTAN", "OAT"  that gives you this rate (with a tiny spread, France being one of the best borrower of the eurozone and also near zero bank margins), the government recently announced measures to ease the access to state debt for consumers.

By definition lending to any other entity will get a higher rate.

And of course banks take their margin for most products, I believe I would get interest of EURIBOR 3 or 6 monthes minus 15 basis point if I block money for the duration at my bank.

by Laurent GUERBY on Sun Dec 24th, 2006 at 04:48:31 AM EST
[ Parent ]
And only the state gets the risk-free rate when they borrow, banks get interbank rates (LIBOR, EURIBOR...) and people get the shaft.

Those whom the Gods wish to destroy They first make mad. -- Euripides
by Migeru (migeru at eurotrib dot com) on Sun Dec 24th, 2006 at 04:52:13 AM EST
[ Parent ]

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