Share Buy Back versus Debt Pay Down
By: Mike Carpenter Manager of Corporate Planning and Analysis Millipore Corporation Summary This article provides a quantitative framework to help CFOs answer the question, “If I have excess cash, would it be more EPS accretive to buy back shares or to pay down debt?” Conceptually, buying back shares increases EPS by lowering the number of shares outstanding, while paying down debt raises EPS by reducing interest expense, which in turn improves earnings. The framework we have developed will guide this managerial decision using eight variables. The result is an equation for a break even stock price, P, below which the company should buy back shares, above which they should pay down debt. While there are other uses of cash besides paying down debt and buying back shares as well as other factors that go into a buy back program besides EPS accretion, the focus of this article is solely related to the financial considerations of these two uses of cash on the current year’s EPS. It is unknown whether this formula has previously been developed. Input Variables The eight variables used for this analysis are listed below. c = Cash available for debt pay down or share buy back ($ in Millions) s = Shares outstanding (average number of shares outstanding in Millions) NI = Forecasted net income ($ in Millions) r = Annual interest rate on debt (%) t = Tax rate (%) f = Fraction of year decision will be implemented (%). (Jan 1 = 100%, mid-year = 50%, etc) x = Cost to implement share buy-back program ($ in Millions) P = Stock price ($/share) This analysis assumes there is no transaction cost associated with using the excess cash to pay down debt. If there is a debt pay down cost, simply set x equal to the difference in costs between starting a share buy back program and increasing the company’s debt pay down program. Share Buy Back Formula
Earnings NI = Share s When a share buy back program is implemented the number of shares (s) decreases,...
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