BHP Billiton (GBR) is the world's largest diversified natural resources company. The company extracts and processes minerals, oil, and gas from its production operations located primarily in Australia, the Americas, and southern Africa. BHP Billiton sells its products globally, with sales and marketing taking place through its principal hubs of The Hague and Singapore. Presented below are some basic facts for BHP Billiton.
Instructions
a. What are some of the reasons that management purchases its own shares?
b. Explain how earnings per share might be affected by treasury share transactions.
c. Calculate the ratio of debt to assets for the current and prior years, and discuss the implications of the change.
SOLUTION
(a) Management might purchase treasury shares to provide to shareholders a tax-efficient method for receiving cash from the corporation. In addition, it might have to repurchase shares to have them available to issue to people exercising options to purchase shares, or management might purchase treasury shares because it feels that its share price is too low. It may believe that by purchasing shares it is signaling to the market that the price is too low. Management might also use excess cash to purchase shares to ward off a hostile takeover. Finally, management might purchase shares in an effort to change its capital structure. If it purchases shares and issues debt (or at least does not retire debt), it will increase the percentage of debt in its capital structure.
(b) Earnings per share is calculated by dividing net income by the weighted-average number of shares outstanding during the year.
If shares are reduced by treasury share purchases, the denominator (weighted-average number of shares outstanding) is reduced. As a result earnings per share is often increased. However, because corporate assets are reduced by the purchase of the treasury shares, earnings potential may decrease. If this occurs, the effect on earnings per share may be mitigated.
(c) One measure of solvency is the ratio of debt divided by total assets. This ratio shows how many dollars of assets are backing up each dollar of debt, should the company become financially troubled. For the current prior year, this can be calculated as follows:
| Current | | Prior |
|---|
| ($66,074 ÷ $138,109) = .48 | | ($62,188 ÷ $129,273) = .48 |
| This represents a stable level in the ratio of debt to assets. It may be determined that BHP Billiton’s solvency is unchanged, but it should definitely be watched, and in comparison to industry averages. | |