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  • 14. Cash dividends reduce cash and retained earnings (except for liquidating dividends which may reduce paid-in capital)
  • 14. If a firm changes its policy, it will just have different investors. Consequently, dividend policy won’t affect the value of the stock.
  • 14. www: Click on the web surfer icon to find out about upcoming stock splits and dividends

Div Div Presentation Transcript

  • Chapter 14 Dividends and Dividend Policy
  • Key Concepts and Skills
    • Understand dividend types and how they are paid
    • Understand the issues surrounding dividend policy decisions
    • Understand the difference between cash and stock dividends
    • Understand why share repurchases are an alternative to dividends
  • Dividend Policy and Stock Value
    • Generate CF’s  Now, two choices:
      • 1. Retain, reinvest CF’s
      • 2. Pay dividends
    • Optimal dividend policy
      • balance between current dividends and future growth  maximizes P0
  • Cash Dividends
    • Regular cash dividend – cash payments made directly to stockholders, usually each quarter
    • Special cash dividend – large dividend that won’t be repeated
    • Liquidating dividend – some or all of the business has been sold
  • Dividend Payment
    • Declaration Date – Board declares the dividend and it becomes a liability of the firm
    • Ex-dividend Date
      • Occurs two business days before date of record
      • If you buy stock on or after this date, you will not receive the dividend
      • Stock price generally drops by about the amount of the dividend
    • Date of Payment – checks are mailed
  • The Ex-Day Price Drop -t -2 -1 0 +1 +2 t $1 is the ex-dividend price drop Price= $10 Price= $9 The stock price will fall by the amount of the dividend on the ex date (Time 0). If the dividend is $1 per share, the price will be equal to $10 – 1 = $9 on the ex date. Before ex date (Time –1) Dividend = $0 Price = $10 On ex date (Time 0) Dividend = $1 Price = $9
  • Does Dividend Policy Matter?
    • Dividends matter – the value of the stock is based on the present value of expected future dividends
    • Dividend policy may not matter
      • Dividend policy is the decision to pay dividends versus retaining funds to reinvest in the firm
      • In theory, if the firm reinvests capital now, it will grow and can pay higher dividends in the future
  • Growth Opportunities
    • Growth comes from reinvesting CF’s
    • If ROE = return on reinvesting:
    • g  ROE * (1 – Payout Ratio)
    • Firms G, C, & TO  Identical firms
    • Each expect EPS1 = $5
    • Each have PO = 1.0 and r = 12.5%
    • Find intrinsic value (P0)
  • Growth Opportunities
    • Firm G cuts PO to 40%, reinvests 60%
    • Assume ROE = 15%
    • D1 = ? g = ?
    • D1 = EPS1 * PO = $2
    • g = ROE * (1 – PO) = 15%*(1 - .4) = 9%
    • P0 = ???
    • P0 = $40  $57.14
  • Growth Opportunities
    • Firm C cuts PO to 40%, reinvests 60%
    • Assume ROE = 12.5%
    • D1 = ? g = ?
    • D1 = EPS1 * PO = $2
    • g = ROE * (1 – PO) = 12.5%*(1 - .4) = 7.5%
    • P0 = ???
    • P0 = $40  $40???
  • Growth Opportunities
    • Firm TO:
    • EPS1 = $5, PO = 40%, D1 = $2
    • r = 12.5%, ROE = 10%
    • P0 = ?
    • P0 = $2  (.125 - .06) = $30.77
    • Dividend policy?
  • Growth Opportunities
    • If ROE (return on reinvested earnings) > r (required return)…
    • NPV (reinvested earnings) > 0
    • Dividend policy?
    • If ROE (return on reinvested earnings) < r (required return)…
    • NPV (reinvested earnings) < 0
    • Dividend policy?
  • Clientele Effect
    • Some investors prefer low dividend payouts and will buy stock in those companies that offer low dividend payouts
    • Some investors prefer high dividend payouts and will buy stock in those companies that offer high dividend payouts
  • Implications of the Clientele Effect
    • What do you think will happen if a firm changes its policy from a high payout to a low payout?
    • What do you think will happen if a firm changes its policy from a low payout to a high payout?
    • If this is the case, does dividend POLICY matter?
      • Policy: Don’t piss off your shareholders.
  • Stock Repurchase
    • Company buys back its own shares of stock
      • Tender offer – company states a purchase price and a desired number of shares
      • Open market – buys stock in the open market
    • Similar to a cash dividend in that it returns cash from the firm to the stockholders
    • Earnings constant, #shares ↓  EPS↑ ,
  • Real-World Considerations
    • Stock repurchase allows investors to decide if they want the current cash flow and associated tax consequences
    • Investors face capital gains taxes instead of ordinary income taxes (lower rate)
    • In our current tax structure, repurchases may be more desirable due to the options provided stockholders
    • The IRS recognizes this and will not allow a stock repurchase for the sole purpose of allowing investors to avoid taxes
  • Information Content of Stock Repurchases
    • Stock repurchases sends a positive signal that management believes that the current price is low
    • The stock price often increases when repurchases are announced
  • Stock Dividends
    • Pay additional shares of stock instead of cash
    • Increases the number of outstanding shares
    • Small stock dividend
      • Less than 20 to 25%
      • If you own 100 shares and the company declared a 10% stock dividend, you would receive an additional 10 shares
    • Large stock dividend – more than 20 to 25%
  • Stock Splits
    • Stock splits – essentially the same as a stock dividend except expressed as a ratio
      • For example, a 2 for 1 stock split is the same as a 100% stock dividend
    • Stock price is reduced when the stock splits
    • Common explanation for split is to return price to a “more desirable trading range”
  • Chapter 14 Quick Quiz
    • What are the different types of dividends and how is a dividend paid?
    • What is the clientele effect and how does it affect dividend policy relevance?
    • What are stock dividends and how do they differ from cash dividends?
    • How are share repurchases an alternative to dividends and why might investors prefer them?