McGraw-Hill/Irwin Copyright © 2015 by The McGraw-Hill Companies, Inc. All rights reserved.

“The times they are a

changin’…”

Bob Dylan

Professor James J. Barkocy

Principles of Corporate Finance

2

Dividend & Stock Repurchases

U.S. Data 1985 - 2017

Ex-dividend Date

3

Dividend Payments

Share Price

Falls

The date on which the firm announces it

intends to pay a dividend

April 25

Declaration Date

Shares start to trade without the dividend,

thus “ex-dividend”

June 14

Shareholders registered on this date will receive the

dividend

June 15

Record Date

The date on which dividend

checks are mailed to the shareholders

July 2

Payment Date

4

Ex-Dividend Price Drop

5

Stock Dividend

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?

Answer

2 mil x .50 = 1 mil + 2 mil = 3 mil shares

6

Stock Dividend

Example – continued - After the stock dividend what

is the new price per share and what is the new

value of the firm?

Answer

The value of the firm was 2 mil x $15 per share, or

$30 mil. After the dividend the value will remain the

same.

Price per share = $30 mil / 3 mil sh = $10 per sh.

7

Dividend vs. Stock Repurchase

Example – Prior to any action

If you owned 1,000 shares they would be worth $10,000

Assets Liabilities & Equity

A. Original balance sheet

Cash $150,000 Debt 0

Other assets 850,000 Equity 1,000,000

Value of Firm 1,000,000 Value of Firm 1,000,000

Shares outstanding = 100,000

Price per share = $1,000,00 0 / 100,000 = $10

8

Dividend vs. Stock Repurchase

Assets Liabilities & Equity

B. After cash dividend

Cash $50,000 Debt 0

Other assets 850,000 Equity 900,000

Value of F irm 900,000 Value of F irm 900,000

Shares outstanding = 100,000

Price per share = $900,000 / 100,000 = $9

Example - Cash dividend

Value of firm drops by $100,000. If you owned 1,000 shares,

you would have $9,000 in stock and $1,000 in cash

9

Dividend vs. Stock Repurchase

Assets Liabilities & Equity

C. After stock repurchase

Cash $50,000 Debt 0

Other assets 850,000 Equity 900,000

Value of F irm 900,000 Value of F irm 900,000

Shares outstanding = 90,000

Price per share = $900,000 / 90,000 = $10

Example – Stock Repurchase

Value of the firm declines, but not the stock price. You

would get: $9,000 in stock, $1000 in cash, or $10,000 in

stock, or $10,000 in cash

10

How Dividends Are Determined

1. Firms have longer term target dividend payout ratios.

2. Managers focus more on dividend changes than on absolute levels.

3. Dividends changes follow shifts in long-run, sustainable levels of earnings rather than short-run changes in earnings.

4. Managers are reluctant to make dividend changes that might have to be reversed.

5. Firms repurchase stock when they have accumulated a large amount of unwanted cash.

11

How Dividends Are Determined

12

Dividend Policy is Irrelevant

Since investors do not need dividends to

convert shares to cash they will not pay higher

prices for firms with higher dividend payouts.

In other words, dividend policy will have no

impact on the value of the firm.

13

Firms Without Sufficient Cash to Pay a Dividend

In a world of personal taxes,

firms should not issue stock to

pay a dividend.

FirmStock

Holders

Cash: stock issue

Cash: dividends

Gov.

Taxes

Investment BankersThe direct costs of stock issuance will add to this effect.

14

Dividends Increase Value

Market Imperfections and Clientele

Effect

• There are natural clients for high-payout stocks, but it does not follow that any particular firm can benefit by increasing its dividends. The high dividend clientele already have plenty of high dividend stock to choose from.

• These clients increase the price of the stock through their demand for a dividend paying stock.

15

Dividends Increase Value

Dividends as Signals

Dividend increases send good news about cash flows

and earnings. Dividend cuts send bad news.

Because a high dividend payout policy will be costly to

firms that do not have the cash flow to support it,

dividend increases signal a company’s good fortune

and its manager’s confidence in future cash flows.

16

Dividends Decrease Value

Tax Consequences

• Companies can convert dividends into capital gains by shifting their dividend policies. If dividends are taxed more heavily than capital gains, taxpaying investors should welcome such a move and value the firm more favorably.

• In such a tax environment, the total cash flow retained by the firm and/or held by shareholders will be higher than if dividends are paid.

• This argument was severely weakened by tax law changes in 2003. Now the tax rate for dividends and capital gains are the same, although there are still a few advantages for capital gains.