Fundamentals of Corporate Finance. Chapter 17 Payout Policy . 1) What are the two ways corporations pay out cash to shareholders? 2) What companies are more likely to pay dividends? 3) What companies are not likely to pay dividends? Give examples. 4) Name and describe the 4 dividend dates. 5) What do states prohibit in regards to dividends? 6) Companies are not allowed to pay dividends past what point? 7) Describe stock dividends and stock splits. 8) What is stock repurchases? 9) Name and describe the 4 methods of stock repurchases. 10) What is green mail? 11) What are some manager’s dividend policies? Describe \"smoothing dividends\". 12) Describe good and bad news regarding stock dividends. 13) What does Modiligliani and Miller\'s argument state?. Solution 1(I) Dividends: This is the most common way to payout cash to shareholders. Dividend is paid annually & the decision to payout dividends totally depends upon the management of the company. (II) Repurchase of Shares: This is another way to payout cash. The repurchase can be done in multiple ways. The most common way is to buy the shares back from the open market on the prevailing prices. The other way is accelerated buy-back. 2) Companies with no better projects & future investment plans are more likely to payout dividends as the company doesn’t have any future projects, which can earn higher return than the market return & hence, they prefer to payout most of the profit through dividend. 3) Companies with a promising future projects, which have potential to generate higher returns, are very less likely to pay dividends as it’s always better to invest in a project with higher returns as it will stimulate growth & increase the value of the company. 4)(I) Declaration Date: The date, when dividends are announced by the board of directors. (II) Date of Record: The date, on which the company will determine its shareholders, or \"holders of record,\" and the company will use this date to establish to whom it will send financial reports, proxy statements and other information. (III) Ex-dividend Date: After the company sets the date of record, the ex-dividend date is set by either the stock exchange or the National Association of Securities Dealers. If an investor purchases a stock on or after its ex-dividend date, he or she will not receive the declared cash dividend; instead, the seller of the stock will be entitled to that dividend. Investors who purchase the stock before the ex-dividend date will receive the dividend. (IV) Payment Date: The date, on which the declared dividend will be paid. 5) Legal-Capital: States prohibit corporations to pay cash dividends from its “Legal Capital”. It refers to the sum of assets contributed to a company by shareholders when they are issued shares. Capital Surplus Account: Corporation are prohibited from paying dividends using the funds from the capital surplus account. Retained Earnings: States also prohibit corporations from paying dividends using their ret.

1. Fundamentals of Corporate Finance. Chapter 17 Payout Policy
. 1) What are the two ways corporations pay out cash to shareholders?
2) What companies are more likely to pay dividends?
3) What companies are not likely to pay dividends? Give examples.
4) Name and describe the 4 dividend dates.
5) What do states prohibit in regards to dividends?
6) Companies are not allowed to pay dividends past what point?
7) Describe stock dividends and stock splits.
8) What is stock repurchases?
9) Name and describe the 4 methods of stock repurchases.
10) What is green mail?
11) What are some manager’s dividend policies? Describe "smoothing dividends".
12) Describe good and bad news regarding stock dividends.
13) What does Modiligliani and Miller's argument state?.
Solution
1(I) Dividends: This is the most common way to payout cash to shareholders. Dividend is paid
annually & the decision to payout dividends totally depends upon the management of the
company.
(II) Repurchase of Shares: This is another way to payout cash. The repurchase can be done in
multiple ways. The most common way is to buy the shares back from the open market on the
prevailing prices. The other way is accelerated buy-back.
2) Companies with no better projects & future investment plans are more likely to payout
dividends as the company doesn’t have any future projects, which can earn higher return than the
market return & hence, they prefer to payout most of the profit through dividend.
3) Companies with a promising future projects, which have potential to generate higher returns,
are very less likely to pay dividends as it’s always better to invest in a project with higher returns
as it will stimulate growth & increase the value of the company.
4)(I) Declaration Date: The date, when dividends are announced by the board of directors.
(II) Date of Record: The date, on which the company will determine its shareholders, or
"holders of record," and the company will use this date to establish to whom it will send
financial reports, proxy statements and other information.
(III) Ex-dividend Date: After the company sets the date of record, the ex-dividend date is set by
either the stock exchange or the National Association of Securities Dealers. If an investor

2. purchases a stock on or after its ex-dividend date, he or she will not receive the declared cash
dividend; instead, the seller of the stock will be entitled to that dividend. Investors who purchase
the stock before the ex-dividend date will receive the dividend.
(IV) Payment Date: The date, on which the declared dividend will be paid.
5) Legal-Capital: States prohibit corporations to pay cash dividends from its “Legal Capital”. It
refers to the sum of assets contributed to a company by shareholders when they are issued shares.
Capital Surplus Account: Corporation are prohibited from paying dividends using the funds from
the capital surplus account.
Retained Earnings: States also prohibit corporations from paying dividends using their retained
earnings.
7) Stock Dividends: The payment made to existing shareholders of a dividend in the form of
stock.
Stock Splits: An issue of new shares in a company to existing shareholders in proportion to
their current holdings.
8) Share Repurchase: A program by which a company buys back its own shares from the
marketplace, reducing the number of outstanding shares.
9) (I)Open Market: The firm buys its stock on the open market from shareholders when the price
is favorable. This method is used for almost 75% of all repurchases.
(II) Repurchase Put Rights: Put rights are the right of the seller to purchase at a certain price, set
ahead of time. If the company has put rights on its shares, it may use them to repurchase shares
at that price.
(III)Fixed Price Tender Offer: The firm announces a number of shares it is looking for and a
fixed price they are willing to pay. Shareholders decide whether or not to sell their shares to the
company.
(IV)Dutch Auction Self-Tender Repurchase: The Company announces a range of prices at which
they are willing to repurchase. Shareholder voluntarily state the price at which they individually
are willing to sell. The company then constructs the supply-curve, and then announces the
purchase price. The company repurchases shares from all shareholders who stated a price at or
below that repurchase price.
10) Greenmail refers to the money that is paid by the target company to another company in
mergers & acquisitions, also known as a corporate raider that has purchased a majority of the
target company's stock. The greenmail payment is made in an attempt to stop the takeover bid.
11)“Smoothing Dividend” is when company keep dividends relative to your Earnings per share.
Most firms will maintain a constant nominal dividend payment until the company’s managers are
convinced that corporate earnings have permanently changed. If the firm’s “permanent earnings”
increase, then managers will increase the nominal dividend payment a little each quarter or year

3. until a new equilibrium level of dividend payments close to the target payout ratio is reached.
The company will then maintain the quarterly or annual dividend at this nominal level until the
firm’s permanent earnings change again. This pattern of stable nominal dividend payments,
followed by slow and steady increases as the firm’s managers adjust to new levels of permanent
earnings, gives the observed dividend series a smooth pattern, so managers are said to smooth
dividends if they follow a constant nominal dividend payment policy with a partial adjustment
strategy.
12) Good News & Bad News: All the stock dividend related news, which increases the stock
price in the market is considered to be a good news, while the stock dividend related news,
which decreases the stock price in the market is interpreted to be a bad news. For example, if the
stock dividend announced by the company is expected & company has satisfactory growth
prospective, the news will act as a positive one & the stock prices will further go up as more
people in the market will try to buy the sock. However, if a company with a very slow or
negative growth prospective announces stock dividends, it will decrease the stock prices in the
market as the company’s value will not increase.
13) This approach advocates capital structure irrelevancy theory. This suggests that the valuation
of a firm is irrelevant to the capital structure of a company. Whether a firm is highly leveraged or
has lower debt component, it has no bearing on its market value. Rather, the market value of a
firm is dependent on the operating profits of the company. This approach further states that the
market value of a firm is affected by its future growth prospect apart from the risk involved in
the investment. The theory stated that value of the firm is not dependent on the choice of capital
structure or financing decision of the firm. If a company has high growth prospect, its market
value is higher and hence its stock prices would be high. If investors do not see attractive growth
prospects in a firm, the market value of that firm would not be that great.