Investment and Debt Capacity
Stock Repurchase
Repurchase of stock can be viewed in each of the following way: investment, financing, shareholder distribution and control issue.
Repurchase of stock can be a way to use firm’s excess debt capacity. By doing so, firm can lower the cost of equity financing. If debt financing is more flexible and cheap, replace equity financing with debt financing is a good way to lower the weighted cost of capital. In this sense, such action is a financing issue because it controls the cost of financing.
On the other hand, repurchase of stock can adjust shareholder distribution. If shareholders consist of most individual investors, they may require more dividends or other forms of profit sharing. Firm can repurchase stocks from such investors so that they can adjust their dividend policy.
If management holds few shares of the company, they may lose their control over operating and strategy decisions. By repurchasing stocks, management could regain majority control over the company on strategic decisions.
Finally, repurchase of stock is also an investment issue because it enables the firm to increase its return on equity by eliminating dilution effect. Higher return on equity will attract more favorable investors as well as better vendors. It has the same outcome of investing in businesses, so it can be viewed as an investment.
Debt Capacity for Stock Repurchase
From Exhibit 5, we get the total debt of Marriott at the end of 1979. We define total debt as sum of short-term loan, current portion of long-term debt, senior debt and capital leases. The average market price of Marriott in 1979 was $14.9, and interest rate for Baa corporate debt was 12%. We assume that Marriott would repurchase stocks at price of $15 using 12% debt financing. Marriott used Adjusted EBIT over net interest as a measure for debt capacity, so we use such measure as well.
The table above shows the main assumptions we make in the analysis. Before the stock repurchase, EBIT
Repurchase of stock can be viewed in each of the following way: investment, financing, shareholder distribution and control issue.
Repurchase of stock can be a way to use firm’s excess debt capacity. By doing so, firm can lower the cost of equity financing. If debt financing is more flexible and cheap, replace equity financing with debt financing is a good way to lower the weighted cost of capital. In this sense, such action is a financing issue because it controls the cost of financing.
On the other hand, repurchase of stock can adjust shareholder distribution. If shareholders consist of most individual investors, they may require more dividends or other forms of profit sharing. Firm can repurchase stocks from such investors so that they can adjust their dividend policy.
If management holds few shares of the company, they may lose their control over operating and strategy decisions. By repurchasing stocks, management could regain majority control over the company on strategic decisions.
Finally, repurchase of stock is also an investment issue because it enables the firm to increase its return on equity by eliminating dilution effect. Higher return on equity will attract more favorable investors as well as better vendors. It has the same outcome of investing in businesses, so it can be viewed as an investment.
Debt Capacity for Stock Repurchase
From Exhibit 5, we get the total debt of Marriott at the end of 1979. We define total debt as sum of short-term loan, current portion of long-term debt, senior debt and capital leases. The average market price of Marriott in 1979 was $14.9, and interest rate for Baa corporate debt was 12%. We assume that Marriott would repurchase stocks at price of $15 using 12% debt financing. Marriott used Adjusted EBIT over net interest as a measure for debt capacity, so we use such measure as well.
The table above shows the main assumptions we make in the analysis. Before the stock repurchase, EBIT