1. Retained Earnings & Excess Cash
If a company is considering returning capital to shareholders, it's really
going to be looking at the balance sheet, and in particular,
with a focus on retained earnings and the balance of retained earnings.
But also the company will be focused on its level of cash,
since if it was to return capital to shareholders, this would be depleting
the cash balance. Assuming the company had a high retained earnings and/or
excess cash balance, it would then engage in the following flow chart.
It would have the high retained earnings for cash balance, so then it
would be looking at the rate of return on capital investment,
and if that was greater than the weighted average cost of capital,
the company would then be re investing in other projects. But if the
rate of return on capital investment was less than the weighted average
cost of capital, the company would be looking to return that to shareholders
in the form of re purchasing shares or paying cash dividends.
2. Let's practice!