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IAI Actuarial Core Principles · Business Finance · Capital structure and dividend policy

A listed Indian company with surplus cash decides to repurchase some of its own shares in the market rather than pay a cash dividend. Which of the following is the most direct effect of the buyback, assuming the shares are cancelled and earnings are unchanged?

Earnings per share rises, because a buyback with cancellation reduces the number of shares while earnings are broadly unchanged. Equity falls rather than rises, so gearing increases, and nominal value per share is not altered by the repurchase.

  1. AEarnings per share rises because the number of shares in issue fallsCorrect
  2. BEarnings per share falls because cash reserves are reduced
  3. CThe number of shares in issue is unchanged but their nominal value rises
  4. DTotal shareholders' funds rise because treasury shares are an asset
  5. Gearing, measured by debt to equity, falls because equity is reduced

Explanation

Cancelling shares reduces the share count. If earnings are unchanged, earnings are spread over fewer shares, so EPS rises (in practice lost interest on cash lowers earnings slightly). Equity falls after a buyback, so gearing rises, not falls.

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