Problem
Flowers N Bloom Co. (Flowers) is a publicly traded company that grows, imports, and distributes flowers in Canada. Flowers has been profitable over the past few years and has accumulated some excess cash. Accordingly, the board of directors is debating how Flowers should distribute some of this cash back to its shareholders. The board is also looking at changing its compensation structure for its executives and requires more information on various forms of share-based payments in order to make this decision. The board has tasked Louise Martin, the chief financial officer, to prepare information for the next board meeting to assist with these decisions. You, CPA, work as an associate with Campbell and Associates LLP, a financial and business advisory firm. Your firm has performed advisory work for Flowers in the past, and Louise has asked your manager, Heather Larimer, for assistance in preparing the required information. Currently, Flowers uses employee stock options to reward its employees. However, some of the board members are concerned about the dilutive impact for shareholders and the fact that, in some cases, these rewards have no value. Consequently, the directors would like to change to another form of share-based payments for its executives. But first, they want to understand alternative types of share-based payments and how these differ from employee stock options. After much discussion at the last meeting, the board decided to stay with equity-settled compensation for now because it strongly believes key managers should be shareholders in the company. In addition to share-based payments, Louise believes that the board should consider a share repurchase. Louise has provided some relevant information about the company in the Appendix.
Task
Describe a share repurchase. Outline the general motivations for and advantages of share repurchases versus cash dividends, along with any disadvantages. Ensure that your discussion considers if and how these factors apply to Flowers.
Additional information provided by Louise Martin
1) During June, the company sold a division for a substantial gain, resulting in a $5,000,000 increase in cash reserves.
2) Available cash to distribute to the shareholders is $7,000,000, including the gain.
3) The company has existing debt with a debt-to-equity covenant with a maximum ratio of 1.7 to 1. Currently, the company has the following balances: debt $48,000,000; equity $34,000,000.
4) The company has 6,000,000 shares outstanding with 2,000,000 owned by management and directors. Ideally, the management and directors would like to own a total of more than 50% in order to have control.
5) Net earnings for the June 30 fiscal year end were $9,300,000, including the gain. Net operating earnings have grown consistently over recent years.
6) Currently, the share price is trading at $15 per share. Management believes that this is below its intrinsic value when compared with competitors.