Answer to Question #6757 in Economics of Enterprise for LaMarcus Streeter

Question #6757
2. Which of the following statements is CORRECT?

a. One disadvantage of dividend reinvestment plans is that they increase transactions costs for investors who want to increase their ownership in the company.
b. One advantage of dividend reinvestment plans is that they enable investors to postpone paying taxes on the dividends credited to their account.
c. Stock repurchases can be used by a firm that wants to increase its debt ratio.
d. Stock repurchases make sense if a company expects to have a lot of profitable new projects to fund over the next few years, provided investors are aware of these investment opportunities.
e. One advantage of an open market dividend reinvestment plan is that it provides new equity capital and increases the shares outstanding.
Expert's answer
Statement C is CORRECT. Stock repurchases reduce the number of shares
outstanding and are often accompanied by a stock price increase. Assets
are reduced (it uses cash to buy back the shares) and stock repurchases reduce
equity. The amount of debt remains unchanged; however, since equity has
decreased the proportion of debt increases. Furthermore, the increase in
debt ratios should increase the riskiness of the stock and lower the
price earnings ratio.

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