dividend policy
TRANSCRIPT
![Page 1: Dividend Policy](https://reader033.vdocuments.us/reader033/viewer/2022061200/5476ce8ab4af9fc4118b4619/html5/thumbnails/1.jpg)
What is “dividend policy”?
It’s the decision to pay out earnings versus retaining and reinvesting them.
Do shareholder’s prefer current or deferred income?
![Page 2: Dividend Policy](https://reader033.vdocuments.us/reader033/viewer/2022061200/5476ce8ab4af9fc4118b4619/html5/thumbnails/2.jpg)
Investors preferences for or against dividends? There are three theories:
The dividend irrelevance theory
The Bird-in-the-hand theory
The Tax preference theory
![Page 3: Dividend Policy](https://reader033.vdocuments.us/reader033/viewer/2022061200/5476ce8ab4af9fc4118b4619/html5/thumbnails/3.jpg)
Dividend Irrelevance Theory
Investors are indifferent between dividends and retention-generated capital gains. If they want cash, they can sell stock. If they don’t want cash, they can use dividends to buy stock.
Modigliani-Miller support irrelevance.Theory is based on unrealistic
assumptions (no taxes or brokerage costs), hence may not be true.
![Page 4: Dividend Policy](https://reader033.vdocuments.us/reader033/viewer/2022061200/5476ce8ab4af9fc4118b4619/html5/thumbnails/4.jpg)
Bird-in-the-Hand Theory
Investors think dividends are less risky than potential future capital gains, hence they like dividends.
If so, investors would value high payout firms more highly, i.e., a high payout would result in a high P0.
![Page 5: Dividend Policy](https://reader033.vdocuments.us/reader033/viewer/2022061200/5476ce8ab4af9fc4118b4619/html5/thumbnails/5.jpg)
Tax Preference Theory
Lower tax rates on capital gains Vs cash dividends motivates shareholders against cash dividends.
Taxes are not paid on the gain until a stock is sold.
This could cause investors to prefer firms with low payouts, i.e., a high payout results in a low P0.
![Page 6: Dividend Policy](https://reader033.vdocuments.us/reader033/viewer/2022061200/5476ce8ab4af9fc4118b4619/html5/thumbnails/6.jpg)
Implications of 3 Theories for Managers
Theory Implication
Irrelevance Any payout OK
Bird-in-the-hand Set high payout
Tax preference Set low payout
But which, if any, is correct???
![Page 7: Dividend Policy](https://reader033.vdocuments.us/reader033/viewer/2022061200/5476ce8ab4af9fc4118b4619/html5/thumbnails/7.jpg)
Possible Stock Price Effects
Stock Price ($)
Payout 50% 100%
40
30
20
10
Bird-in-Hand
Indifference
Tax preference
0
![Page 8: Dividend Policy](https://reader033.vdocuments.us/reader033/viewer/2022061200/5476ce8ab4af9fc4118b4619/html5/thumbnails/8.jpg)
Possible Cost of Equity Effects
Cost of equity (%)
Payout 50% 100%
15
20
10
Tax Preference
Indifference
Bird-in-Hand
0
![Page 9: Dividend Policy](https://reader033.vdocuments.us/reader033/viewer/2022061200/5476ce8ab4af9fc4118b4619/html5/thumbnails/9.jpg)
Which theory is most correct?
Empirical testing has not been able to determine which theory, if any, is correct.
Thus, managers use judgment when setting policy.
Analysis is used, but it must be applied with judgment.
![Page 10: Dividend Policy](https://reader033.vdocuments.us/reader033/viewer/2022061200/5476ce8ab4af9fc4118b4619/html5/thumbnails/10.jpg)
What’s the “information content,” or “signaling,” hypothesis?
Managers hate to cut dividends, so won’t raise dividends unless they anticipate higher earnings in the future.
A higher then expected increase is a “signal” to investors that the firms management forecasts good earnings.
A dividend reduction or a smaller than expected increase is a signal that management is forecasting poor earnings.
![Page 11: Dividend Policy](https://reader033.vdocuments.us/reader033/viewer/2022061200/5476ce8ab4af9fc4118b4619/html5/thumbnails/11.jpg)
What’s the “clientele effect”?
Different groups, or clienteles of stockholders, prefer different dividend policies.
Firm’s past dividend policy determines its current clientele of investors.
Clientele effects impede changing dividend policy. Taxes & brokerage costs hurt investors who have to switch companies.
![Page 12: Dividend Policy](https://reader033.vdocuments.us/reader033/viewer/2022061200/5476ce8ab4af9fc4118b4619/html5/thumbnails/12.jpg)
What’s the “residual dividend model”?
Find the retained earnings needed for the capital budget.
Pay out any leftover earnings (the residual) as dividends.
This policy minimizes flotation and equity signaling costs, hence minimizes the WACC.
![Page 13: Dividend Policy](https://reader033.vdocuments.us/reader033/viewer/2022061200/5476ce8ab4af9fc4118b4619/html5/thumbnails/13.jpg)
Using the Residual Model to Calculate Dividends Paid
Dividends = – .Net
income
Targetequityratio
Totalcapitalbudget[ ]))((
![Page 14: Dividend Policy](https://reader033.vdocuments.us/reader033/viewer/2022061200/5476ce8ab4af9fc4118b4619/html5/thumbnails/14.jpg)
Data for SSC
Capital budget: $800,000. Given.
Target capital structure: 40% debt, 60% equity. Want to maintain.
Forecasted net income: $600,000.
How much of the $600,000 should we pay out as dividends?
![Page 15: Dividend Policy](https://reader033.vdocuments.us/reader033/viewer/2022061200/5476ce8ab4af9fc4118b4619/html5/thumbnails/15.jpg)
Of the $800,000 capital budget, 0.6($800,000) = $480,000 must be equity to keep at target capital structure. [0.4($800,000) = $320,000 will be debt.]
With $600,000 of net income, the residual is $600,000 - $480,000 = $120,000 = dividends paid.
Payout ratio = $120,000/$600,000 = 0.20 = 20%.
![Page 16: Dividend Policy](https://reader033.vdocuments.us/reader033/viewer/2022061200/5476ce8ab4af9fc4118b4619/html5/thumbnails/16.jpg)
How would a drop in NI to $400,000 affect the dividend? A rise to
$800,000?
NI = $400,000: Need $480,000 of equity, so should retain the whole $400,000. Dividends = 0.
NI = $800,000: Dividends = $800,000 - $480,000 = $320,000. Payout = $320,000/$800,000 = 40%.
![Page 17: Dividend Policy](https://reader033.vdocuments.us/reader033/viewer/2022061200/5476ce8ab4af9fc4118b4619/html5/thumbnails/17.jpg)
How would a change in investment opportunities affect dividend under the
residual policy?
Fewer good investments would lead to smaller capital budget, hence to a higher dividend payout.
More good investments would lead to a lower dividend payout.
![Page 18: Dividend Policy](https://reader033.vdocuments.us/reader033/viewer/2022061200/5476ce8ab4af9fc4118b4619/html5/thumbnails/18.jpg)
Advantages and Disadvantages of the Residual Dividend Policy
Advantages: Minimizes new stock issues and flotation costs.
Disadvantages: Results in variable dividends, sends conflicting signals, increases risk, and doesn’t appeal to any specific clientele.
Conclusion: Consider residual policy when setting target payout, but don’t follow it rigidly.
![Page 19: Dividend Policy](https://reader033.vdocuments.us/reader033/viewer/2022061200/5476ce8ab4af9fc4118b4619/html5/thumbnails/19.jpg)
Dividend Payment Procedures
Mar 8 Mar 20 Mar 22 Apr 18
Declaration Ex-dividend Record Paymentdate date date date
Share price falls
![Page 20: Dividend Policy](https://reader033.vdocuments.us/reader033/viewer/2022061200/5476ce8ab4af9fc4118b4619/html5/thumbnails/20.jpg)
1.Declaration date: The date on which the board of directors passes a resolution to pay a dividend.
2.Ex-dividend date: The date two business days before the date of record, establishing those individuals entitled to a dividend.
3.Date of record: The date by which a holder must be on record in order to be designated to receive a dividend.
4.Payment date: The date the dividend checks are mailed.
![Page 21: Dividend Policy](https://reader033.vdocuments.us/reader033/viewer/2022061200/5476ce8ab4af9fc4118b4619/html5/thumbnails/21.jpg)
Dividend Payments
1.Stock Dividends
2.Stock Splits
3.Stock Repurchase
![Page 22: Dividend Policy](https://reader033.vdocuments.us/reader033/viewer/2022061200/5476ce8ab4af9fc4118b4619/html5/thumbnails/22.jpg)
Example - Amoeba Products has 2 million shares currently outstanding at a price of $15 per share. The company declares a 50% stock dividend. How many shares will be outstanding after the dividend is paid?
Stock Dividend - Distribution of additional shares to a firm’s
stockholders.
![Page 23: Dividend Policy](https://reader033.vdocuments.us/reader033/viewer/2022061200/5476ce8ab4af9fc4118b4619/html5/thumbnails/23.jpg)
Answer
2 mil x .50 = 1 mil + 2 mil = 3 million shares
![Page 24: Dividend Policy](https://reader033.vdocuments.us/reader033/viewer/2022061200/5476ce8ab4af9fc4118b4619/html5/thumbnails/24.jpg)
Example - cont - After the stock dividend what is the new price per share and what is the new value of the firm?
![Page 25: Dividend Policy](https://reader033.vdocuments.us/reader033/viewer/2022061200/5476ce8ab4af9fc4118b4619/html5/thumbnails/25.jpg)
Answer
Price per share = $30 mil / 3 mil sh = $10 per sh.
The value of the firm before was 2 mil x $15 per share, or $30 mil.
After the dividend the value will remain the same. 3 million x $10 per share, or $30 mil.
![Page 26: Dividend Policy](https://reader033.vdocuments.us/reader033/viewer/2022061200/5476ce8ab4af9fc4118b4619/html5/thumbnails/26.jpg)
Example - Amoeba Products has 2 million shares currently outstanding at a price of $15 per share. The company declares a 3 for 1 stock split.What is the new amount of shares you will own?
Stock Splits - Issue of additional shares to firm’s stockholders.
![Page 27: Dividend Policy](https://reader033.vdocuments.us/reader033/viewer/2022061200/5476ce8ab4af9fc4118b4619/html5/thumbnails/27.jpg)
Answer:
Number of shares = 2 million x 3
= 6 million shares
![Page 28: Dividend Policy](https://reader033.vdocuments.us/reader033/viewer/2022061200/5476ce8ab4af9fc4118b4619/html5/thumbnails/28.jpg)
Example - cont - After the stock split what is the new price per share and what is the new value of the firm?
![Page 29: Dividend Policy](https://reader033.vdocuments.us/reader033/viewer/2022061200/5476ce8ab4af9fc4118b4619/html5/thumbnails/29.jpg)
Answer
Price per share = $15 / 3 = $5 per sh.
The value of the firm before was 2 mil x $15 per share, or $30 mil.
After the stock split the value will remain the same. 6 million x $5 per share, or $30 mil
![Page 30: Dividend Policy](https://reader033.vdocuments.us/reader033/viewer/2022061200/5476ce8ab4af9fc4118b4619/html5/thumbnails/30.jpg)
Stock Repurchases
Reasons for repurchases:As an alternative to distributing cash as
dividends.To dispose of one-time cash from an
asset sale.To make a large capital structure
change.
Repurchases: Buying own stock back from stockholders.
![Page 31: Dividend Policy](https://reader033.vdocuments.us/reader033/viewer/2022061200/5476ce8ab4af9fc4118b4619/html5/thumbnails/31.jpg)
Example:-
ABC Company has after-tax earnings of S5 million and 2,500,000 shares of common stock outstanding. Also suppose the stock trades at a P/E ratio of 10. Then EPS and market price as follows:
EPS = EAT = 5,000,000 = $2.0
Number of shares 2,500,000
Market price = EPS x P/E = $2.0 x 10 =$20.0
![Page 32: Dividend Policy](https://reader033.vdocuments.us/reader033/viewer/2022061200/5476ce8ab4af9fc4118b4619/html5/thumbnails/32.jpg)
Now suppose ABC has $1 million that it can distribute in dividends. If it does so, the dividend per share will be
dividend= $1,000,000 = $0.40 per
2,500,000 shares
However, suppose the company uses the$1 million to buy its own shares instead of paying a dividend. Then it can purchase and retire
$1,000,000 = 50,000 shares
$20
![Page 33: Dividend Policy](https://reader033.vdocuments.us/reader033/viewer/2022061200/5476ce8ab4af9fc4118b4619/html5/thumbnails/33.jpg)
After the repurchase , there will be
2,500,000 – 50,000 = 2,450,000 shares
Left outstanding. If earnings don’t change EPS will then be
EPS = $5,000,000 = $2.04 per share
2,450,000
Finally, if the P/E remains the same, the market price of the remaining shares will be
Market price = EPS x P/E = 2.04 x 10= $ 20.40