ACCA Advanced Financial Management (AFM) Practice Exam

What is a potential downside for a company when repurchasing its own shares?

1. Increased number of shareholders

2. Potential to pay too much for its own stock

3. Lower overall cash reserves

4. Reduction in market share

The correct answer is: Potential to pay too much for its own stock

When a company undertakes a share repurchase, it buys back its own shares from the marketplace, which can lead to several financial implications. One significant downside is the potential to pay too much for its own stock. If a company repurchases shares when the stock price is inflated or overvalued, it can lead to a misallocation of resources. The capital used for the buyback could have been invested in more productive avenues, such as research and development, expansion, or paying down debt. Moreover, if shareholders perceive that the company is overpaying for its shares, it can lead to a loss of confidence in the management's decision-making capabilities, affecting the company's future stock performance. This downside highlights the importance of management judgment in determining the right timing and price for share buybacks, which requires careful financial analysis and market evaluation. In summary, the risk of overpayment during share repurchases poses a substantial threat to shareholder value and overall financial health, making it a critical consideration for any company engaging in this strategy.