ACCA Advanced Financial Management (AFM) Practice Exam

How might a company signal it has excess cash on hand?

1. By issuing new shares

2. By increasing its operational budget

3. By conducting stock repurchases

4. By reducing debt obligations

The correct answer is: By conducting stock repurchases

A company may signal that it has excess cash on hand through stock repurchases, also known as share buybacks. When a company conducts stock repurchases, it typically indicates that management believes the company's shares are undervalued, or it has confident expectations for future earnings. This move serves multiple purposes, including providing a return of capital to shareholders and potentially increasing the earnings per share (EPS) by reducing the number of shares outstanding. Moreover, stock buybacks can also reflect that the company has sufficient liquidity and cash flow to undertake such actions, reinforcing the notion that it is in a strong financial position. Companies often opt for buybacks rather than paying dividends because buybacks offer more flexibility in capital management and can positively influence their stock price. In contrast, other actions, such as issuing new shares, increasing operational budgets, or reducing debt obligations, typically do not convey the same clear message of having excess cash. Issuing new shares can often be perceived as a need for capital, increasing operational budgets does not directly signal excess cash, and reducing debt obligations may reflect prudent financial management but does not specifically indicate surplus cash availability.