ACCA Advanced Financial Management (AFM) Practice Exam

What is typically true about stock repurchase as a method of returning cash to shareholders?

1. It reduces the number of outstanding shares

2. It is mandatory for all public companies

3. It is more favorable than dividends every time

4. It must be authorized by shareholders

The correct answer is: It reduces the number of outstanding shares

Stock repurchase, also known as share buyback, is a corporate action where a company buys back its own shares from the existing shareholders, which leads to a reduction in the number of outstanding shares in the market. This practice can have several implications for the company's financials and the value of remaining shares. When a company repurchases its shares, the proportionate ownership of each remaining shareholder increases since there are fewer shares outstanding. This can often lead to an increase in earnings per share (EPS), as the company's earnings are distributed over a smaller number of shares, potentially making the stock more attractive to investors. Additionally, reducing the outstanding share count can enhance shareholder value and may support an increase in the stock price if the market perceives the buyback as a sign of confidence in the company’s future prospects. In contrast, the other options do not accurately reflect the realities of stock repurchase. It is not mandatory for public companies to execute stock buybacks; such actions are usually at the discretion of the company management. Stock repurchases are not always more favorable than dividends, as preferences for returning cash to shareholders can vary depending on tax implications, individual shareholder circumstances, and current market conditions. Furthermore, although companies may choose to authorize buybacks through board