7. dividend policy.ppt
TRANSCRIPT
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2002, Prentice Hall, Inc.
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Stock Returns:
P1- Po + D1
PoReturn =
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P1- Po + D1
Po
P1 - Po D1
Po Po+
Return =
=
Stock Returns:
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Return =
Capital Gain
P1- Po + D1
Po
P1 - Po D1
Po Po+=
Stock Returns:
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Return =
Capital Gain DividendYield
+=
Stock Returns:
P1- Po + D1
Po
P1 - Po D1
Po Po
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Dilemma: Should the firm use
retained earnings for:
a) Financing profitable capital
investments?
b) Paying dividends to stockholders?
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If we retain earnings for profitable
investments,
P1 - Po D1
Po Po
+Return =
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If we retain earnings for profitable
investments, dividend yield will be zero,
P1 - Po D1
Po Po
+Return =
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If we retain earnings for profitable
investments, dividend yield will be zero,but the stock price will increase, resulting
in a higher capital gain.
P1 - Po D1
Po Po
+Return =
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If we pay dividends,
P1 - Po D1
Po Po
+Return =
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If we pay dividends, stockholders receive
an immediate cash reward for investing,
P1 - Po D1
Po Po
+Return =
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If we pay dividends, stockholders receive
an immediate cash reward for investing,but the capital gain will decrease, since
this cash is not invested in the firm.
P1 - Po D1
Po Po
+Return =
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So, dividend policy really
involves 2 decisions:
How much of the firms earnings
should be distributed to
shareholders as dividends, and
How much should be retained for
capital investment?
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I s Dividend Policy Important?
Three viewpoints:
1) Dividends are Irrelevant. If we
assume perfect markets (no taxes,no transaction costs, etc.) dividends
do not matter. If we pay a
dividend, shareholders dividendyield rises, but capital gains
decrease.
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With perfect markets, investors are
concerned only with total returns,and do not care whether returns
come in the form of capital gainsor
dividend yields.
P1 - Po D1
Po Po
+Return =
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With perfect markets, investors are
concerned only with total returns,and do not care whether returns
come in the form of capital gains or
dividend yields.
P1 - Po D1
Po Po
+Return =
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With perfect markets, investors are
concerned only with total returns,and do not care whether returns
come in the form of capital gains or
dividend yields. Therefore, one dividend policy is as
good as another.
P1 - Po D1
Po Po
+Return =
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2) H igh Dividends are Best
Some investors may prefer a certain
dividendnow over a risky expected
capital gainin the future.
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2) H igh Dividends are Best
Some investors may prefer a certain
dividendnow over a risky expected
capital gainin the future.
P1 - Po D1
Po Po+Return =
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3) Low Dividends are Best
Dividends are taxed immediately.
Capital gains are not taxed until the
stock is sold.
Therefore, taxes on capital gains can
be deferred indefinitely.
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Dividends I rrelavence
Example
Q: The WWs are retirees with most of their savings invested in10,000 shares of Ajax Corporation (AJAX). AJAX sells for $10per share and pays an annual dividend of $0.50 per share. Thisyear AJAX eliminated the dividend but began to grow at 5% ayear due to the reinvested earnings. How can the Winters
maintain their income and their position in AJAX?A: Their original value of AJAX shares was $10 per share 10,000
shares, or $100,000, which they wish to maintain. But, theywere generating an annual dividend of 10,000 shares $0.50 or$5,000 before AJAX eliminated the dividend. After one year of
5% growth, AJAXs shares should be selling for $10.50. Thus,by selling 476 shares ($5,000 $10.50) they can generate$5,000 in cash. Their remaining 9,524 shares would be worth$10.50 each for a total of $100,002.
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Do Dividends Matter?
Other Considerations:
1) Residual Dividend Theory:
The firm pays a dividend only if it hasretained earnings left after financing
all profitable investment
opportunities. This would maximize capital gains for
stockholders and minimize flotation
costs of issuing new common stock.
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Do Dividends Matter?
2) Clientele Effects:
Different investor clienteles prefer different
dividend payout levels.
Some firms, such as utilities, pay out over70% of their earnings as dividends. These
attract a clientele that prefers high
dividends. Growth-oriented firms which pay low (or
no) dividends attract a clientele that prefers
price appreciation to dividends.
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Do Dividends Matter?
3) Information Effects:
Unexpected dividend increases
usually cause stock prices to rise, and
unexpected dividend decreases cause
stock prices to fall.
Dividend changes convey informationto the market concerning the firms
future prospects.
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Do Dividends Matter?
4) Agency Costs: Paying dividends reduces retained
earnings and forces the firm to raise
external equity financing. Raising external equity subjects the firm
to scrutiny of regulators (SEC) and
investors and therefore helps monitor the
performance of managers.
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Do Dividends Matter?
5) Expectations Theory:
Investors form expectations concerning
the amount of a firms upcoming
dividend.
Expectations are based on past dividends,
expected earnings, investment and
financing decisions, the economy, etc.
The stock price will likely react if the
actual dividendis different from the
expected dividend.
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Dividend Policies
1) Constant Dividend Payout Ratio: ifdirectors declare a constant payout
ratio of, for example, 30%, then for
every dollar of earnings available tostockholders, 30 cents would be paid
out as dividends.
The ratio remains constant over time,
but the dollar value of dividends
changesas earnings change.
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Dividend Policies
2) Stable Dollar Dividend Policy:
the firm tries to pay a fixed dollar
dividend each quarter. Firms and stockholders prefer
stable dividends. Decreasing the
dividend sends a negative signal!
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Dividend Policies
3) Small Regular Dividend plus Year-End Extras
The firm pays a stable quarterly
dividend and includes an extra year-end dividend in prosperous years.
By identifying the year-end dividend
as extra, directors hope to avoidsignalingthat this is a permanentdividend.
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Dividend Payments
1) Declaration Date: the board ofdirectors declares the dividend,
determines the amount of the dividend,
and decides on the payment date.
Jan.4 Jan.30 Feb.1 Mar. 11
Declare Ex-div. Record Payment
dividend date date date
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Dividend Payments
2) Ex-Dividend Date:
Jan.4 Jan.30 Feb.1 Mar. 11
Declare Ex-div. Record Payment
dividend date date date
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Dividend Payments
2) Ex-Dividend Date: To receive thedividend, you have to buy the stock before
the ex-dividend date. On this date, the
stock begins trading ex-dividend and
the stock price falls approximately by the
amount of the dividend.
Jan.4 Jan.30 Feb.1 Mar. 11
Declare Ex-div. Record Payment
dividend date date date
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Dividend Payments
3) Date of Record:
Jan.4 Jan.30 Feb.1 Mar. 11
Declare Ex-div. Record Payment
dividend date date date
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Dividend Payments
3) Date of Record: 2 days after the ex-dividend date, the firm receives the list ofstockholders eligible for the dividend.
Often, a bank trust department acts asregistrar and maintains this list for thefirm.
Jan.4 Jan.30 Feb.1 Mar. 11
Declare Ex-div. Record Payment
dividend date date date
4 30 1 11
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Dividend Payments
4) Payment Date: date on which thefirm mails the dividend checks to the
shareholders of record.
Jan.4 Jan.30 Feb.1 Mar. 11
Declare Ex-div. Record Payment
dividend date date date
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Stock Dividends and Stock Spli ts
Stock dividend: payment of additional
shares of stock to common stockholders.
Example: Citizens Bancorporation of
Maryland announces a 5% stock
dividend to all shareholders of record.
For each 100 shares held, shareholders
receive another 5 shares.
Does the shareholders wealth increase?
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Stock Dividends and Stock Spli ts
Stock Split: the firm increases the number
of shares outstanding and reduces the
price of each share.
Example: Joule, Inc. announces a 3-for-2
stock split. For each 100 shares held,
shareholders receive another 50 shares.
Does this increase shareholder wealth?
Are a stock dividend and a stock split the
same?
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Stock Dividends and Stock Spli ts
Stock Splits and Stock Dividends are
economically the same: the number of
shares outstanding increases and the priceof each share drops. The value of the firm
does not change.
Example: A 3-for-2 stock split is the sameas a 50% stock dividend. For each 100
shares held, shareholders receive another
50 shares.
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Stock Dividends and Stock Spli ts
Effects on Shareholder Wealth:
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Stock Dividends and Stock Spli ts
Effects on Shareholder Wealth: these will
cut the company pie into more pieces
but will not create wealth. A 100% stock
dividend (or a 2-for-1 stock split) givesshareholders 2 half-sized pieces for each
full-sized piece they previously owned.
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Stock Dividends and Stock Spli ts
Effects on Shareholder Wealth: these will
cut the company pie into more pieces
but will not create wealth. A 100% stock
dividend (or a 2-for-1 stock split) givesshareholders 2 half-sized pieces for each
full-sized piece they previously owned.
For example, this would double thenumber of shares, but would cause a $60
stock price to fall to $30.
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Stock Dividends and Stock Spli ts
Why bother?
Proponents argue that these are used to
reduce high stock prices to a more
popular trading range(generally $15 to$70 per share).
Opponents argue that most stocks are
purchased by institutional investors whohave millions of dollars to invest and are
indifferent to price levels. Plus, stock splits
and stock dividends are expensive!
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Stock Dividend Example
shares outstanding: 1,000,000
net income = $6,000,000;
P/E = 10 25%stock dividend.
An investor has 120 shares. Does the
value of the investors shares
change?
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Before the 25% stock dividend:
EPS = 6,000,000/1,000,000 = $6 P/E = P/6 = 10, so P = $60 per share.
Value = $60 x 120 shares = $7,200
After the 25% stock dividend:
# shares = 1,000,000 x 1.25 = 1,250,000.
EPS = 6,000,000/1,250,000 = $4.80
P/E = P/4.80 = 10, so P = $48 per share.
Investor now has 120 x 1.25 = 150 shares.
Value = $48 x 150 = $7,200
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Stock Dividends
In-class Problem
shares outstanding: 250,000
net income = $750,000;
stock price = $84
50% stock dividend.
What is the new stock price?
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Hint:
stock price
P/E = net income
# shares( )
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Before the 50% stock dividend:
EPS = 750,000 / 250,000 = $3
P/E = 84 / 3 = 28.
After the 50% stock dividend: # shares = 250,000 x 1.50 = 375,000.
EPS = 750,000 / 375,000 = $2
P/E = P / 2 = 28, so P = $56per share.
(a 50% stock dividend is equivalent to a
3-for-2 stock split)
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Stock Repurchases
Stock Repurchases may be a goodsubstitute for cash dividends.
If the firm has excess cash, why not
buy back common stock?
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Stock Repurchases
Stock Repurchases may be a goodsubstitute for cash dividends.
If the firm has excess cash, why not
buy back common stock?
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Stock Repurchases
Repurchases drive up the stockprice, producing capital gains forshareholders.
Repurchases increase leverage, andcan be used to move toward theoptimal capital structure.
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Stock Repurchases
Repurchases may be used to avoid
a hostile takeover.
Example: T. Boone Pickensattempted raids on PhillipsPetroleum and Unocal in 1985.Both were unsuccessful because
the target firms undertook stockrepurchases.
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Stock Repurchases
Methods: Buy shares in the open market
through a broker.
Buy a large blockby negotiating thepurchase with a large block holder,
usually an institution (targeted stock
repurchase).
Tender offer: offer to pay a specific