Strategic Finance

1. Dividend Policy

2. Dividends and Distribution
Dividend is usually referred to as firm’s earnings to the owners, in the form
of either cash or stock
 Distribution is a payment made by the firm to its owners from its sources
other than current or accumulated retained earnings.

3. Choice of Payout Policy
Companies pay out cash to their shareholders in two ways:
 pay a dividend
 buy back some of the outstanding shares

4. How companies pay Dividends
 A company’s dividend is set by the board of directors
Announcement of dividends takes place…
1)Announcement: “payment will be made to all stockholders who are
registered on a particular record date”
2) Then a week or so later dividend cheques are mailed to stock holders
3)Stocks are normally bought or sold with dividend (or cum dividend) until
two business days before the record date and then they trade ex-dividend
4) If stock is bought on the ex-dividend date, your purchase will not be
entered on the company’s books before the record date and you will not
be entitled to the dividend.

5. How dividends are paid…
Exxon Mobile
declares
dividend of
$0.50 per share
Shares start to
trade ex-
dividend
Dividend will be
paid to S/h
registered on
this date
Dividend
cheques are
mailed to S/h
Jan 31, 2009 Feb 7, 2009
Declaration
date
Ex-dividend
date
Record
date
Payment
date
Feb 9, 2009 Mar 9, 2009

6. How firms repurchase stock
Instead of paying dividend to its stockholders, a firm can use the cash to
repurchase stock.
Four main ways to repurchase stock are:
a) Firm announces that it plans to buy its stock in the open market.
b) Sometimes a ‘tender offer’ is given to buy at about 20% above the
current market level
c) ‘Dutch auction’ is the case where the firm states a series of prices at
which it is prepared to repurchase stock. Share holders submit offers
and the company calculates the lowest price for buying shares
d) Repurchase may take place by direct negotiation with a major shareholder.

7. The information in Dividends and
Stock Repurchases
Q. How does an investor in financial world separate a small sized
Profitable firms from real money makers?
Ans. One clue is dividends…
Investor’s can’t read managers’ minds but they can learn from
managers’ actions…
 They know a firm that supports good earnings and pays generous
dividend would only create interest for them.
 Firms cannot dodge it’s investors in long term by overstating earnings
and paying large payouts in cash dividends

8. The information in Dividends and
Stock Repurchases cont…
** If a firm chooses a high dividend payout with the cash flow to back it up,
that firm will ultimately have to:
-reduce it’s investment plans
-Or turn to investors for additional debt or equity financing
Therefore, most managers don’t increase dividends until they are confident
that sufficient cash flow will flow in to pay them.

9. Establishing Dividend Policy Strategy…
RESIDUAL DIVIDEND APPROACH
 Firm with higher dividends payout will have to sell stock more often.
 Such sales is ‘expensive’
 We assume that firm minimizes need to sell new equity
 Also firm wishes to maintain current capital structure
 If new equity sales is to be avoided then firm will rely on internally
generated equity to finance new profitable projects and dividends
are only paid out of what is left over (residual)
 This left over is Residual dividend approach

10. Problems
1) The Readata Corporation practices a strict residual dividend policy and
maintains a capital structure of 60% debt, 40% equity. Earnings for the year are
$5000. What is the maximum amount of capital spending possible without selling
new equity? Suppose the planned investment outlay for the coming year are
$12000. Will Readata be paying a dividend? If so, how much.

11. 2) Soprano Co., a litter recycling company, uses a residual dividend policy.
A debt-equity ratio of 1.20 is considered optimal. Earnings for the period just
ended were $1500 and a dividend of $390 was declared. How much in new
debt was borrowed. What were total capital outlays?