Page 25 - CIMA SCS Workbook February 2019 - Day 2 Suggested Solutions

CIMA FEBRUARY 2019 – STRATEGIC CASE STUDY

Another problem of paying a scrip dividend is that it increases the number of shares without
helping to increase earnings. Therefore earnings per share, which is a key performance measure
for listed companies, will fall.

Finally, from an accounting point of view, paying a scrip dividend converts distributable reserves
(retained earnings) into share capital. This capitalisation of reserves might restrict the ability of
Vita to pay a cash dividend in the future.

Share repurchase
Definition

In a share repurchase, the company offers to buy back some of the shares from its shareholders.
So there is a payment of cash to shareholders, and the total number of shares in issue reduces.

Advantages and disadvantages of a share repurchase
A share repurchase would leave fewer shares in issue, so Vita’s earnings per share would rise. This
increase would send a positive signal to the stock market.
Unlike with a scrip dividend, a share repurchase does involve a payment of cash from the
company to its shareholders. If Vita were to undertake a share repurchase it would have to find
the cash from somewhere, perhaps by increasing borrowings or by using some of its existing cash
resources (that might have already been earmarked for research and investment). Increasing
borrowings would be the more sensible option here, given that Vita’s gearing is extremely low at
the moment.

Increasing gearing and using the money to repurchase shares would be seen as a positive move by
the market. However, the main problem with a share repurchase is deciding what price to offer to
shareholders. If the share price has been volatile recently, it will not be easy for Vita to decide
what a fair price should be. If the price offered ends up being lower than the share price on the
day of the share repurchase, the shareholders will not accept the repurchase offer.
Conclusion
Both a scrip dividend and a share repurchase have advantages and disadvantages to Vita. The
main thing to consider though before embarking on one of these strategies is the likely reaction of
the shareholders. Chris Heloise suggests that both options would be perceived as a positive signal
to the market, but we should check that this is also the view of the other shareholders before we
decide which option to choose (if either).

84 KAPLAN PUBLISHING