Asw

ath Dam

odaran127

Returning C

ash to the Ow

ners:D

ividend Policy

Asw

ath Dam

odaran

Asw

ath Dam

odaran128

First P

rinciples

Invest in projects that yield a return greater than the minim

umacceptable hurdle rate.•

The hurdle rate should be higher for riskier projects and reflect the

financing mix used - ow

ners’ funds (equity) or borrowed m

oney (debt)

•R

eturns on projects should be measured based on cash flow

s generatedand the tim

ing of these cash flows; they should also consider both positive

and negative side effects of these projects.

Choose a financing m

ix that minim

izes the hurdle rate and matches the

assets being financed.

If there are not enough investments that earn the hurdle rate,

return the cash to stockholders.•

The form

of returns - dividends and stock buybacks - will depend

upon the stockholders’ characteristics.

Objective: M

aximize the V

alue of the Firm

Asw

ath Dam

odaran129

Dividends are sticky

Dividend C

hanges : 1989-1998

0.00%

10.00%

20.00%

30.00%

40.00%

50.00%

60.00%

19891990

19911992

19931994

19951996

19971998

Year

% of all firms

Increasing dividendsD

ecreasing dividendsN

ot changing dividends

Asw

ath Dam

odaran130

Dividends tend to follow

earnings

Figure 21.5: D

ividends and Earnings at U

S F

irms: 1960 - 1998

0.0

0

5.0

0

10

.00

15

.00

20

.00

25

.00

30

.00

35

.00

40

.00

45

.00

1960

1961

1962

1963

1964

1965

1966

1967

1968

1969

1970

1971

1972

1973

1974

1975

1976

1977

1978

1979

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

Year

$ Dividends/Earnings

Earnings

Dividends

Asw

ath Dam

odaran131

More and m

ore firms are buying back stock,

rather than pay dividends...

Fig

ure

2

2.1

: S

toc

k

Bu

yb

ac

ks

a

nd

D

ivid

en

ds

: A

gg

reg

ate

fo

r U

S

Firm

s

- 1

98

9-9

8

$-

$5

0,0

00

.00

$1

00

,00

0.0

0

$1

50

,00

0.0

0

$2

00

,00

0.0

0

$2

50

,00

0.0

0

19

88

19

89

19

90

19

91

19

92

19

93

19

94

19

95

19

96

19

97

19

98

Ye

ar

Stock B

uybacksD

ivide

nd

s

Asw

ath Dam

odaran132

Measures of D

ividend Policy

Dividend Payout:

• m

easures the percentage of earnings that the company pays in dividends

•=

Dividends / E

arnings

Dividend Y

ield:

•m

easures the return that an investor can make from

dividends alone

•=

Dividends / Stock Price

Asw

ath Dam

odaran133

Dividend P

ayout Ratios: January 2002

0

20

40

60

80

100

120

140

160

180

0-5%

5-10%

10-15%

15-20%

20-25%

25-30%

30-35%

35-40%

40-45%

45-50%

50-60%

60-70%

70-80%

80-90%

90-100%

>100%

Div

iden

d P

ayo

ut R

atio

s: Jan

uary

20

02

Firm

s paying/not paying dividends

0

500

1000

1500

2000

2500

Pay divid

ends

Pay no d

ividen

ds

Number of firms

Asw

ath Dam

odaran134

Dividend Y

ields in the United S

tates: January2002

0

50

100

150

200

2500-0.25%

0.25-0.5%0.5-0.75%

0.75-%

1-1.25%

1-1.5%1.5-1.75%

1.75-2%

2-2.5%

2.5-3%

3-3.5%

3.5-4%

4-5%

>5%

Div

iden

d Y

ield

s: Jan

uary

20

02

Num

ber o

f divid

end Payin

g firm

s = 1

800

Num

ber o

f non-d

ividen

d Payin

g firm

s = 3

971

Asw

ath Dam

odaran135

Three S

chools Of T

hought On D

ividends

1. If •

(a) there are no tax disadvantages associated with dividends

•(b) com

panies can issue stock, at no cost, to raise equity, whenever

needed

•D

ividends do not matter, and dividend policy does not affect value.

2. If dividends have a tax disadvantage,

•D

ividends are bad, and increasing dividends will reduce value

3. If stockholders like dividends, or dividends operate as a signal of future prospects,

•D

ividends are good, and increasing dividends will increase value

Asw

ath Dam

odaran136

The balanced view

point

If a company has excess cash, and few

good projects (NPV

>0),

returning money to stockholders (dividends or stock repurchases) is

GO

OD

.

If a company does not have excess cash, and/or has several good

projects (NPV

>0), returning m

oney to stockholders (dividends orstock repurchases) is B

AD

.

Asw

ath Dam

odaran137

Why do firm

s pay dividends?

The M

iller-Modigliani H

ypothesis: Dividends do not affect value

Basis:•

If a firm's investm

ent policy (and hence cash flows) don't change, the

value of the firm cannot change w

ith dividend policy. If we ignore

personal taxes, investors have to be indifferent to receiving eitherdividends or capital gains.

Underlying A

ssumptions:

•(a) T

here are no tax differences between dividends and capital gains.

•(b) If com

panies pay too much in cash, they can issue new

stock, with no

flotation costs or signaling consequences, to replace this cash.

•(c) If com

panies pay too little in dividends, they do not use the excesscash for bad projects or acquisitions.

Asw

ath Dam

odaran138

The T

ax Response: D

ividends are taxed more

than capital gains

Basis:•

Dividends are taxed m

ore heavily than capital gains. A stockholder w

illtherefore prefer to receive capital gains over dividends.

Evidence:•

Exam

ining ex-dividend dates should provide us with som

e evidence onw

hether dividends are perfect substitutes for capital gains.

Asw

ath Dam

odaran139

Price B

ehavior on Ex-D

ividend Date

Let P

b = Price before the stock goes ex-dividend

Pa =

Price after the stock goes ex-dividend D

= D

ividends declared on stock to , tcg =

Taxes paid on ordinary incom

e and capital gains respectively

$ Pb$Pa

______________|_______ Ex-Dividend Day _______________|

Asw

ath Dam

odaran140

Cashflow

s from S

elling around Ex-D

ividendD

ay

The cash flow

s from selling before then are-

Pb - (P

b - P) tcgT

he cash flows from

selling after the ex-dividend day are-P

a - (Pa - P) tcg +

D(1-to )

Since the average investor should be indifferent between selling before

the ex-dividend day and selling after the ex-dividend day -P

b - (Pb - P) tcg =

Pa - (P

a - P) tcg + D

(1-to )M

oving the variables around, we arrive at the follow

ing:

Asw

ath Dam

odaran141

Price C

hange, Dividends and T

ax Rates

IfP

b - Pa =

Dthen

to = tcg

Pb - P

a < D

then to >

tcgP

b - Pa >

Dthen

to < tcg

Pb−

Pa

D =

(1

-to )

(1−

tcg )

Asw

ath Dam

odaran142

The E

vidence on Ex-D

ividend Day B

ehavior

OrdinaryInco

meCapital

Gains(

Pb-

Pa )/D

Before1981

70%

28%

0.78(1966-69)

1981-8550

%20

%0.85

1986-199028

%28

%0.90

1991-199333

%28

%0.92

1994..39.6

%28

%0.90

Asw

ath Dam

odaran143

Dividend A

rbitrage

Assum

e that you are a tax exempt investor, and that you know

that theprice drop on the ex-dividend day is only 90%

of the dividend. How

would you exploit this differential?

Invest in the stock for the long term

Sell short the day before the ex-dividend day, buy on the ex-dividendday

Buy just before the ex-dividend day, and sell after.

______________________________________________

Asw

ath Dam

odaran144

Exam

ple of dividend capture strategy with tax

factors

XY

Z com

pany is selling for $50 at close of trading May 3. O

n May 4,

XY

Z goes ex-dividend; the dividend am

ount is $1. The price drop

(from past exam

ination of the data) is only 90% of the dividend

amount.

The transactions needed by a tax-exem

pt U.S. pension fund for the

arbitrage are as follows:

•1. B

uy 1 million shares of X

YZ

stock cum-dividend at $50/share.

•2. W

ait till stock goes ex-dividend; Sell stock for $49.10/share (50 - 1*0.90)

•3. C

ollect dividend on stock.

Net profit =

- 50 million +

49.10 million +

1 million =

$0.10 million

Asw

ath Dam

odaran145

The w

rong reasons for paying dividendsT

he bird in the hand fallacy

Argum

ent: Dividends now

are more certain than capital gains later.

Hence dividends are m

ore valuable than capital gains.

Counter: T

he appropriate comparison should be betw

een dividendstoday and price appreciation today. (T

he stock price drops on the ex-dividend day.)

Asw

ath Dam

odaran146

The excess cash hypothesis

Argum

ent: The firm

has excess cash on its hands this year, noinvestm

ent projects this year and wants to give the m

oney back tostockholders.

Counter: So w

hy not just repurchase stock? If this is a one-time

phenomenon, the firm

has to consider future financing needs.C

onsider the cost of issuing new stock:

Asw

ath Dam

odaran147

The C

ost of Raising F

unds

Issuing new equity is m

uch more expensive than raising new

debt forcom

panies that are already publicly traded, in terms of transactions

costs and investment banking fees

Raising sm

all amounts is m

uch more expensive than raising large

amounts, for both equity and debt. M

aking a small equity issue ( say $

25-$ 50 million m

ight be prohibitively expensive)

Asw

ath Dam

odaran148

Are firm

s perverse? Som

e evidence that theyare not

Asw

ath Dam

odaran149

Evidence from

Canadian F

irms

Com

panyP

remium

for Cash dividend over

Stock Dividend Shares

Consolidated Bathurst19.30%

Donfasco13.30%

Dome Petroleum

0.30%

Imperial Oil

12.10%

New

foundland Light & Pow

er1.80%

Royal Trustco17.30%

Stelco2.70%

TransAlta1.10%

Average

7.54%

Asw

ath Dam

odaran150

A clientele based explanation

Basis: Investors m

ay form clienteles based upon their tax brackets.

Investors in high tax brackets may invest in stocks w

hich do not paydividends and those in low

tax brackets may invest in dividend paying

stocks.

Evidence: A

study of 914 investors' portfolios was carried out to see if

their portfolio positions were affected by their tax brackets. T

he studyfound that•

(a) Older investors w

ere more likely to hold high dividend stocks and

•(b) Poorer investors tended to hold high dividend stocks

Asw

ath Dam

odaran151

Results from

Regression: C

lientele Effect

Dividend Y

ieldt = a + b βt + c Aget + d Incom

et + e Differential Tax R

atet + εt

Variable

Coefficient

Implies

Constant

4.22%

Beta C

oefficient-2.145

Higher beta stocks pay low

er dividends.

Age/100

3.131Firm

s with older investors pay higher

dividends.

Income/1000

-3.726Firm

s with w

ealthier investors pay lower

dividends.

Differential Tax R

ate-2.849

If ordinary income is taxed at a higher rate

than capital gains, the firm pays less

dividends.

Asw

ath Dam

odaran152

Dividend P

olicy and Clientele

Assum

e that you run a phone company, and that you have historically

paid large dividends. You are now

planning to enter thetelecom

munications and m

edia markets. W

hich of the following paths

are you most likely to follow

?

Courageously announce to your stockholders that you plan to cut

dividends and invest in the new m

arkets.

Continue to pay the dividends that you used to, and defer investm

entin the new

markets.

Continue to pay the dividends that you used to, m

ake the investments

in the new m

arkets, and issue new stock to cover the shortfall

Other

Asw

ath Dam

odaran153

The S

ignaling Hypothesis

Asw

ath Dam

odaran154

An A

lternative Story..D

ividends as Negative

Signals

Asw

ath Dam

odaran155

The W

ealth Transfer H

ypothesis

-2

-1.5 -1

-0.5 0

0.5

t:-1

5-1

2-9

-6-3

03

69

12

15

CA

R (D

iv Up)

CA

R (D

iv down)

EX

CE

SS

RE

TUR

NS

ON

STR

AIG

HT B

ON

DS

AR

OU

ND

DIV

IDE

ND

CH

AN

GE

S

Day (0: A

nnouncement date)

CAR

Asw

ath Dam

odaran156

Managem

ent Beliefs about D

ividend Policy

A firm

’s dividend payout ratio affects its stock price.

Dividend paym

ents operate as a signal to financial markets

Dividend announcem

ents provide information to financial m

arkets.

Investors think that dividends are safer than retained earnings

Investors are not indifferent between dividends and price appreciation.

Stockholders are attracted to firms that have dividend policies that they

like.

Asw

ath Dam

odaran157

Determ

inants of Dividend P

olicy

Investment O

pportunities: More investm

ent opportunities - > L

ower

Dividends

Stability in earnings: More stable earnings ->

Higher D

ividends

Alternative sources of capital: M

ore alternative sources -> H

igherD

ividends

Constraints: M

ore constraints imposed by bondholders and lenders ->

Low

er Dividends

Signaling Incentives: More options to supply inform

ation to financialm

arkets - Low

er need to pay dividends as signal

Stockholder characteristics: Older, poorer stockholders ->

Higher

dividends

Asw

ath Dam

odaran158

Questions to A

sk in Dividend P

olicy Analysis

How

much could the com

pany have paid out during the period underquestion?

How

much did the the com

pany actually pay out during the period inquestion?

How

much do I trust the m

anagement of this com

pany with excess

cash?•

How

well did they m

ake investments during the period in question?

•H

ow w

ell has my stock perform

ed during the period in question?

Asw

ath Dam

odaran159

A M

easure of How

Much a C

ompany C

ouldhave A

fforded to Pay out: F

CF

E

The Free C

ashflow to E

quity (FCFE

) is a measure of how

much cash

is left in the business after non-equity claimholders (debt and preferred

stock) have been paid, and after any reinvestment needed to sustain the

firm’s assets and future grow

th.N

et Income

+ D

epreciation & A

mortization

= C

ash flows from

Operations to E

quity Investors

- Preferred Dividends

- Capital E

xpenditures

- Working C

apital Needs

- Principal Repaym

ents

+ Proceeds from

New

Debt Issues

= Free C

ash flow to E

quity

Asw

ath Dam

odaran160

Estim

ating FC

FE

when Leverage is S

table

Net Incom

e

- (1- δ) (Capital E

xpenditures - Depreciation)

- (1- δ) Working C

apital Needs

= Free C

ash flow to E

quity

δ = D

ebt/Capital R

atio

For this firm,

•Proceeds from

new debt issues =

Principal Repaym

ents + δ (C

apitalE

xpenditures - Depreciation +

Working C

apital Needs)

Asw

ath Dam

odaran161

An E

xample: F

CF

E C

alculation

Consider the follow

ing inputs for Microsoft in 1996. In 1996,

Microsoft’s FC

FE w

as:•

Net Incom

e = $2,176 M

illion

•C

apital Expenditures =

$494 Million

•D

epreciation = $ 480 M

illion

•C

hange in Non-C

ash Working C

apital = $ 35 M

illion

•D

ebt Ratio =

0%

FCFE

= N

et Income - (C

ap ex - Depr) (1-D

R) - C

hg WC

(!-DR

) =

$ 2,176- (494 - 480) (1-0)

- $ 35 (1-0)

=

$ 2,127 Million

Asw

ath Dam

odaran162

Microsoft: D

ividends?

By this estim

ation, Microsoft could have paid $ 2,127 M

illion individends/stock buybacks in 1996. T

hey paid no dividends and boughtback no stock. W

here will the $2,127 m

illion show up in M

icrosoft’sbalance sheet?

Asw

ath Dam

odaran163

Dividends versus F

CF

E: U

.S.

Fig

ure

1

1.1

: D

ivid

en

ds

/FC

FE

:

NY

SE

F

irms

in

1

99

6

0

20

0

40

0

60

0

80

0

10

00

12

00

14

00

16

00

18

00

0 %

0 -10%

10 -20%

20- 30%

30 - 40%

4 0 - 5 0 %

50 - 60%

60 -70%

70 - 80%

80 -90%

90 - 100%

> 100%

Div

ide

nd

s/F

CF

E

Number of Firms

Asw

ath Dam

odaran164

The C

onsequences of Failing to pay F

CF

E

Ch

rys

ler: F

CF

E, D

ivid

en

ds

an

d C

as

h B

ala

nc

e

($5

00

)

$0

$5

00

$1

,00

0

$1

,50

0

$2

,00

0

$2

,50

0

$3

,00

0

19

85

19

86

19

87

19

88

19

89

19

90

19

91

19

92

19

93

19

94

Ye

ar

Cash Flow

$0

$1

,00

0

$2

,00

0

$3

,00

0

$4

,00

0

$5

,00

0

$6

,00

0

$7

,00

0

$8

,00

0

$9

,00

0

Cash Balance

= F

ree

CF

to E

qu

ity =

Ca

sh to

Sto

ckho

lde

rsC

umulated C

ash

Asw

ath Dam

odaran165

Application T

est: Estim

ating your firm’s

FC

FE

In General,

If cash flow statem

ent usedN

et Income

Net Incom

e+

Depreciation &

Am

ortization+

Depreciation &

Am

ortization- C

apital Expenditures

+ C

apital Expenditures

- Change in N

on-Cash W

orking Capital

+ C

hanges in Non-cash W

C- Preferred D

ividend+

Preferred Dividend

- Principal Repaid

+ Increase in L

T B

orrowing

+ N

ew D

ebt Issued+

Decrease in L

T B

orrowing

+ C

hange in ST B

orrowing

= FCFE

= FCFE

Com

pare toD

ividends (Com

mon)

-Com

mon D

ividend+

Stock Buybacks

- Decrease in �

�C

apital Stock+ Increase in �

Capital Stock

Asw

ath Dam

odaran166

A P

ractical Fram

ework for A

nalyzing Dividend

Policy

How

much did the firm

pay out? How

much could it have afforded to pay out?

What it could have paid out

What it actually paid out

Net Incom

eD

ividends- (C

ap Ex - D

epr’n) (1-DR

)+

Equity R

epurchase- C

hg Working C

apital (1-DR

)= F

CF

E

Firm

pays out too littleF

CF

E > D

ividendsF

irm pays out too m

uchF

CF

E < D

ividends

Do you trust m

anagers in the company w

ithyour cash?Look at past project choice:C

ompare

RO

E to C

ost of Equity

RO

C to W

AC

C

What investm

ent opportunities does the firm

have?Look at past project choice:C

ompare

RO

E to C

ost of Equity

RO

C to W

AC

C

Firm

has history of good project choice and good projects in the future

Firm

has historyof poor project choice

Firm

has good projects

Firm

has poor projects

Give m

anagers the flexibility to keep cash and set dividends

Force m

anagers to justify holding cash or return cash to stockholders

Firm

should cut dividends and reinvest m

ore

Firm

should deal w

ith its investment

problem first and

then cut dividends

Asw

ath Dam

odaran167

A D

ividend Matrix

FC

FE

- Divid

end

s

Good P

rojectsP

oor Projects

Maxim

umF

lexibility in D

ividend Policy

Reduce cash

payout to stockholders

Significant

pressureon m

anagers to pay cash out

Investment and

Dividend

problems; cut

dividends but also check project choice

Asw

ath Dam

odaran168

Disney: A

n analysis of FC

FE

from 1992-1996

Year

Net Incom

e(C

ap Ex- D

epr) C

hg in WC

FC

FE

(1- Debt R

atio)(1-D

ebt Ratio)

1992$817

$173 ($81)

$725

1993$889

$328 $160

$402

1994$1,110

$469 $498

$143

1995$1,380

$325 $206

$849

1996*$1,214

$466 ($470)

$1,218

Avge

$1,082 $352

$63$667

(The num

bers for 1996 are reported without the C

apital Cities

Acquisition)

The debt ratio used to estim

ate the free cash flow to equity w

as estimated

as follows =

Net D

ebt Issues/(Net C

ap Ex +

Change in N

on-cash WC

)

Asw

ath Dam

odaran169

Disney’s D

ividends and Buybacks from

1992 to1996

Year

FCFE

Dividends +

Stock Buybacks

1992$725

$105

1993$402

$160

1994$143

$724

1995$849

$529

1996$1,218

$733

Average

$667 $450

Asw

ath Dam

odaran170

Disney: D

ividends versus FC

FE

Disney paid out $ 217 m

illion less in dividends (and stock buybacks)than it could afford to pay out. H

ow m

uch cash do you think Disney

accumulated during the period?

Asw

ath Dam

odaran171

Can you trust D

isney’s managem

ent?

During the period 1992-1996, D

isney had•

an average return on equity of 21.07% on projects taken

•earned an average return on 21.43%

for its stockholders

•a cost of equity of 19.09%

Disney has taken good projects and earned above-m

arket returns for itsstockholders during the period.

If you were a D

isney stockholder, would you be com

fortable with

Disney’s dividend policy?

Yes

No

Asw

ath Dam

odaran172

Disney: R

eturn Perform

ance Trends

Re

turn

s o

n E

qu

ity, S

toc

k a

nd

Re

qu

ired

Re

turn

s - D

isn

ey

-10

.00

%

0.0

0%

10

.00

%

20

.00

%

30

.00

%

40

.00

%

50

.00

%

60

.00

%

19

92

19

93

19

94

19

95

19

96

Ye

ar

RO

ER

etu

rns o

n S

tock

Re

qu

ired

Re

turn

Asw

ath Dam

odaran173

The B

ottom Line on D

isney Dividends

Disney could have afforded to pay m

ore in dividends during the periodof the analysis.

It chose not to, and used the cash for the AB

C acquisition.

The excess returns that D

isney earned on its projects and its stock overthe period provide it w

ith some dividend flexibility. T

he trend in thesereturns, how

ever, suggests that this flexibility will be rapidly depleted.

The flexibility w

ill clearly not survive if the AB

C acquisition does not

work out.

Asw

ath Dam

odaran174

Aracruz: D

ividends and FC

FE

: 1994-1996

19941995

1996N

et Income

BR

248.21 B

R326.42

BR

47.00 - (C

ap. Exp - D

epr)*(1-DR

)B

R174.76

BR

197.20 B

R14.96

- ∂ Working C

apital*(1-DR

)(B

R47.74)

BR

15.67 (B

R23.80)

= Free C

F to Equity

BR

121.19 B

R113.55

BR

55.84

Dividends

BR

80.40 B

R113.00

BR

27.00 +

Equity R

epurchasesB

R 0.00

BR

0.00B

R 0.00

= C

ash to StockholdersB

R80.40

BR

113.00 B

R27.00

Asw

ath Dam

odaran175

Aracruz: Investm

ent Record

19941995

1996P

roject Perform

ance Measures

RO

E19.98%

16.78%2.06%

Required rate of return

3.32%28.03%

17.78% D

ifference16.66%

-11.25%-15.72%

Stock Perform

ance Measure

Returns on stock

50.82%-0.28%

8.65%R

equired rate of return3.32%

28.03%17.78%

Difference

47.50%-28.31%

-9.13%

Asw

ath Dam

odaran176

Aracruz: Its your call..

Assum

e that you are a large stockholder in Aracruz. T

hey have ahistory of paying less in dividends than they have available in FC

FEand have accum

ulated a cash balance of roughly 1 billion BR

(25% of

the value of the firm). W

ould you trust the managers at A

racruz with

your cash?

Yes

No

Asw

ath Dam

odaran177

Mandated D

ividend Payouts

There are m

any countries where com

panies are mandated to pay out a

certain portion of their earnings as dividends. Given our discussion of

FCFE

, what types of com

panies will be hurt the m

ost by these laws?

Large com

panies making huge profits

Small com

panies losing money

High grow

th companies that are losing m

oney

High grow

th companies that are m

aking money

Asw

ath Dam

odaran178

BP

: Dividends- 1983-92

12

34

56

78

910

Net Incom

e$1,256.00

$1,626.00$2,309.00

$1,098.00$2,076.00

$2,140.00$2,542.00

$2,946.00$712.00

$947.00

- (Cap. E

xp - Depr)*(1-D

R)

$1,499.00$1,281.00

$1,737.50$1,600.00

$580.00$1,184.00

$1,090.50$1,975.50

$1,545.50$1,100.00

∂ Working C

apital*(1-DR

)$369.50

($286.50)$678.50

$82.00($2,268.00)

($984.50)$429.50

$1,047.50($305.00)

($415.00)

= Free C

F to Equity

($612.50)$631.50

($107.00)($584.00)

$3,764.00$1,940.50

$1,022.00($77.00)

($528.50)$262.00

Dividends

$831.00$949.00

$1,079.00$1,314.00

$1,391.00$1,961.00

$1,746.00$1,895.00

$2,112.00$1,685.00

+ E

quity Repurchases

= C

ash to Stockholders$831.00

$949.00$1,079.00

$1,314.00$1,391.00

$1,961.00$1,746.00

$1,895.00$2,112.00

$1,685.00

Dividend R

atios

Payout Ratio

66.16%58.36%

46.73%119.67%

67.00%91.64%

68.69%64.32%

296.63%177.93%

Cash Paid as %

of FCFE

-135.67%150.28%

-1008.41%-225.00%

36.96%101.06%

170.84%-2461.04%

-399.62%643.13%

Perform

ance Ratios

1. Accounting M

easure

RO

E9.58%

12.14%19.82%

9.25%12.43%

15.60%21.47%

19.93%4.27%

7.66%

Required rate of return

19.77%6.99%

27.27%16.01%

5.28%14.72%

26.87%-0.97%

25.86%7.12%

Difference

-10.18%5.16%

-7.45%-6.76%

7.15%0.88%

-5.39%20.90%

-21.59%0.54%

Asw

ath Dam

odaran179

BP

: Sum

mary of D

ividend Policy

Summ

ary of calculations

Average

Standard Deviation

Maxim

umM

inimum

Free C

F to E

quity$571.10

$1,382.29$3,764.00

($612.50)

Dividends

$1,496.30$448.77

$2,112.00$831.00

Dividends+

Repurchases

$1,496.30$448.77

$2,112.00$831.00

Dividend P

ayout Ratio

84.77%

Cash P

aid as % of F

CF

E262.00%

RO

E - R

equired return-1.67%

11.49%20.90%

-21.59%

Asw

ath Dam

odaran180

BP

: Just Desserts!

Asw

ath Dam

odaran181

The Lim

ited: Sum

mary of D

ividend Policy:

1983-1992

Summ

ary of calculations

Average

Standard Deviation

Maxim

umM

inimum

Free C

F to E

quity($34.20)

$109.74$96.89

($242.17)

Dividends

$40.87$32.79

$101.36$5.97

Dividends+

Repurchases

$40.87$32.79

$101.36$5.97

Dividend P

ayout Ratio

18.59%

Cash P

aid as % of F

CF

E-119.52%

RO

E - R

equired return1.69%

19.07%29.26%

-19.84%

Asw

ath Dam

odaran182

Grow

th Firm

s and Dividends

High grow

th firms are som

etimes advised to initiate dividends because

its increases the potential stockholder base for the company (since

there are some investors - like pension funds - that cannot buy stocks

that do not pay dividends) and, by extension, the stock price. Do you

agree with this argum

ent?

Yes

No

Why?

Asw

ath Dam

odaran183

Application T

est: Assessing your firm

’sdividend policy

Com

pare your firm’s dividends to its FC

FE, looking at the last 5 years

of information.

Based upon your earlier analysis of your firm

’s project choices, would

you encourage the firm to return m

ore cash or less cash to its owners?

If you would encourage it to return m

ore cash, what form

should ittake (dividends versus stock buybacks)?

Asw

ath Dam

odaran184

Other A

ctions that affect Stock P

rices

In the case of dividends and stock buybacks, firms change the value of

the assets (by paying out cash) and the number of shares (in the case of

buybacks).T

here are other actions that firms can take to change the value of their

stockholder’s equity.•

Divestitures: T

hey can sell assets to another firm that can utilize them

more efficiently, and claim

a portion of the value.•

Spin offs: In a spin off, a division of a firm is m

ade an independent entity.T

he parent company has to give up control of the firm

.•

Equity carve outs: In an E

CO

, the division is made a sem

i-independententity. T

he parent company retains a controlling interest in the firm

.•

Tracking Stock: W

hen tracking stock are issued against a division, theparent com

pany retains complete control of the division. It does not have

its own board of directors.

Asw

ath Dam

odaran185

Differences in these actions

Asset com

pletelycovenrted into cash

No cash for

transaction

Control fully lost

Parent com

panhy preservescontrol

Taxed on capital gains

No T

axes

Bondholders negatively

affected

Bondholders

unaffected

Divestitures

Spin offs

EC

OTracking stock

Divestitures

Spin offs

EC

OTracking stock

Divestitures

Spin offs

Divestitures

Tracking stock

EC

Os

Trackingstock

Spin offs

EC

O