Kellogg Company is the world’s leading producer of ready-to-eat cereal products. In recent years, the company has taken numerous steps aimed at improving its profitability and earnings per share. Presented below are some basic facts for Kellogg.
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Instructions
(a) What are some of the reasons that management purchases its own stock?
(b) Explain how earnings per share might be affected by treasury stock transactions.
(c) Calculate the ratio of debt to assets for 2010 and 2011, and discuss the implications of the change.

SOLUTION:

(a) Management might purchase treasury stock to provide to stockholders 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 stock, or management might purchase treasury stock because it feels that its stock 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 stock to ward off a hostile takeover. Finally, management might purchase stock in an effort to change its capital structure. If it purchases stock 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 stock 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 stock, 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