Referring to example 12 under Share Repurchase solution. If the company issue another debt to buy back its shares, why did the cash reduce? It is logical that debt will increase by the amount of the new debt issued, but it has nothing to do with the current cash at hand, so I am confused as to why cash had to reduce. Pls come to my rescue. Thanks.
I checked it there is no such contradiction. Have a look again tomorrow. Must be seeing ghosts.
Give an example…by first instance without reading the question, if company issues debt to make repurchase this is same as borrow to payoff dividend. Thus, cash inflow (debt emission) - cash outflow (stock repurchase) at the same moment. What is left?
The cost of debt, thus paid interests reduces cash.
^ That is a good observation
OK, from your analysis, it is the cost of debt that reduces cash, and not the value of issued debt itself. But in the example, say for instance the company issued debt of 40 to repurchase shares worth 40, CFA sokution reduces cash by the same 400. Is it possible to look at it this way… Debt was raised to buy the shares, so debt increases, and then cash was used to pay down the debt which reduces cash and also debt from its initial position. I need you to be more precise Flashback… Thanks.
OK, School example
Company G/L (+ debit; - credit). Borrowings for stock repurchase program (once-off).
Debt emission
Cash account Debt Account
1000 + 1000 -
Stock repurchase
Cash account Equity account
1000 - 1000 +
Debt settlement with 100$ Interest exp. (assuming once off settlement - school example)
Cash account Debt account
1000 - 1000 +
Accrued interest
P/L - Int. exp. Short -term Int. liability
100 + 100 -
Interest payment
Cash account Short -term Int. liability
100 - 100+
Hope this helps…
OK… Thank you.
Bottom line:
Cash -1.100 (deduction)
Equity decreased by 1.000 (stock repurchased and prefix + means deduction of equity position)
Equity decreased by additional 100 through P/L by interest expense (assuming no taxes in this example).