Lecture_7___Payout_Policy_Fall08

Lecture_7___Payout_Policy_Fall08 - Corporate Financial...

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Corporate Financial Policy (NBA 558) Payout Policy Johnson Graduate School of  Management Fall 2008 Prof. Mark Leary
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2 What is payout policy? FCF is the equity holders’ money. What do we do with it? Three options: Keep it in the firm (excess cash) Pay it out to shareholders (dividend) Repurchase shares EBIT -Interest Taxable income -Taxes Net income +Depreciation -New investment -Principal payments FCF to equity Dividends Repurchase Retain cash Timing of payout Now Now Later Form of payout Cash Capital gain Capital gain
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3 Perfect markets – Payout policy irrelevance ABC, Inc. is all-equity financed (10 million shares outstanding), has assets with a market value of $100 million and just received a cash flow of $10 million. Shareholder wealth if I own 1 share: Keep the cash in the firm: P = (100+10)/10 = $11 Pay the cash out as a dividend: P = 100/10 = $10 Cash = 10/10 = $1 Repurchase shares: n*P = 10 P = 100/(10-n) P = (100+10)/10 = $11
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4 Dividend Timing NEW YORK, June 1 /PRNewswire/ -- The Board of Directors of Verizon Communications Inc. (NYSE:VZ) today declared a quarterly dividend of 40.5 cents per outstanding share, unchanged from the previous quarter. The dividend is payable on Aug. 1, 2006, to Verizon Communications shareowners of record at the close of business on July 10, 2006. When does the informational content of the dividend impact the share price? When does the mechanical effect of the dividend impact the share price? June 1 July 6 July 10 (Mon.) Aug 1 Declaration Date Ex-dividend Date Record Date Payment Date
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5 Dividend Timing Source: Chetty, Rosenberg and Saez (2005)
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6 Ex-day price changes Notation: – P cum = price prior to the ex-date (i.e. the share sells with the dividend) – P ex = price on or after the ex-date – t d = personal tax on dividend income t g = personal tax on capital gains If Verizon paid a $1 dividend, what should be the change in price on the ex-date (P cum - P ex ) in perfect capital markets: With personal taxes: Consider the following strategy: Buy the stock just before markets close on July 5 Sell again just after markets open July 6 What does it cost?
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