Fin320-CH13 - Chapter 13 Dividend Policy and Internal...

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Unformatted text preview: Chapter 13 Dividend Policy and Internal Financing Stock Returns: Return = P1 - Po + D1 Po Po Stock Returns: Return = P1 - Po Po Po P1 - Po + D1 Po Po D1 + Po = Stock Returns: Return = Return P1 - Po Po Po P1 - Po + D1 Po Po D1 + Po = Capital Gain Stock Returns: Return = Return P1 - Po Po P1 - Po + D1 Po Po D1 + Po Po Dividend Yield Yield = Capital Gain Dilemma: Should the firm use retained earnings for: a) Financing profitable capital a) investments? investments? b) Paying dividends to stockholders? Return = P1 - Po Po Po + D1 Po s If we retain earnings for profitable If investments, investments, Return = P1 - Po Po Po + D1 Po s If we retain earnings for profitable If investments, dividend yield will be zero, dividend Return = P1 - Po Po Po + D1 Po s If we retain earnings for profitable If investments, dividend yield will be zero, but the stock price will increase, resulting in a higher capital gain. in Return = P1 - Po Po Po + D1 Po s If we pay dividends, If Return = P1 - Po Po Po + D1 Po s If we pay dividends, stockholders receive If an immediate cash reward for investing, an Return = P1 - Po Po Po + D1 Po s If we pay dividends, stockholders receive If an immediate cash reward for investing, but the capital gain will decrease, since this cash is not invested in the firm. this So, dividend policy really involves 2 decisions: s How much of the firm’s earnings How should be distributed to shareholders as dividends, and shareholders s How much should be retained for How capital investment? capital Is Dividend Policy Important? Three viewpoints: 1) Dividends are Irrelevant. If we Dividends assume perfect markets (no taxes, no transaction costs, etc.) dividends do not matter. If we pay a dividend, shareholders’ dividend yield rises, but capital gains decrease. decrease. Return = P1 - Po Po Po + D1 Po s With perfect markets, investors are With concerned only with total returns, and do not care whether returns come in the form of capital gains or capital dividend yields. dividend Return = P1 - Po Po Po + D1 Po s With perfect markets, investors are With concerned only with total returns, and do not care whether returns come in the form of capital gains or dividend yields. dividend Return = P1 - Po Po Po + D1 Po s With perfect markets, investors are With concerned only with total returns, and do not care whether returns come in the form of capital gains or dividend yields. dividend s Therefore, one dividend policy is as Therefore, good as another. good 2) High Dividends are Best s Some investors may prefer a certain Some dividend now over a risky expected dividend capital gain in the future. capital 2) High Dividends are Best s Some investors may prefer a certain Some dividend now over a risky expected dividend capital gain in the future. capital P1 - Po Po Po D1 Po Return = + 3) Low Dividends are Best s Dividends are taxed immediately. Dividends taxed Capital gains are not taxed until the stock is sold. stock s Therefore, taxes on capital gains can Therefore, be deferred indefinitely. be Do Dividends Matter? Other Considerations: 1) Residual Dividend Theory: s The firm pays a dividend only if it has The retained earnings left after financing all profitable investment opportunities. opportunities. s This would maximize capital gains for This stockholders and minimize flotation costs of issuing new common stock. costs Do Dividends Matter? 2) Clientele Effects: s Different investor clienteles prefer different Different dividend payout levels. dividend s Some firms, such as utilities, pay out over Some 70% of their earnings as dividends. These attract a clientele that prefers high dividends. dividends. s Growth-oriented firms which pay low (or Growth-oriented no) dividends attract a clientele that prefers price appreciation to dividends. price Do Dividends Matter? 3) Information Effects: s Unexpected dividend increases Unexpected usually cause stock prices to rise, and unexpected dividend decreases cause stock prices to fall. s Dividend changes convey information Dividend to the market concerning the firm’s future prospects. future Do Dividends Matter? 4) Agency Costs: s Paying dividends may reduce agency Paying costs between managers and shareholders. shareholders. s Paying dividends reduces retained Paying earnings and forces the firm to raise external equity financing. external s Raising external equity subjects the firm Raising to scrutiny of regulators (SEC) and investors and therefore helps monitor the performance of managers. performance Do Dividends Matter? 5) Expectations Theory: s Investors form expectations concerning Investors the amount of a firm’s upcoming dividend. dividend. s Expectations are based on past dividends, Expectations expected earnings, investment and financing decisions, the economy, etc. financing s The stock price will likely react if the The actual dividend is different from the actual expected dividend. expected Dividend Policies 1) Constant Dividend Payout Ratio: if 1) Constant directors declare a constant payout ratio of, for example, 30%, then for every dollar of earnings available to stockholders, 30 cents would be paid out as dividends. out s The ratio remains constant over time, The but the dollar value of dividends changes as earnings change. changes Dividend Policies 2) Stable Dollar Dividend Policy: 2) Stable the firm tries to pay a fixed dollar dividend each quarter. dividend s Firms and stockholders prefer Firms stable dividends. Decreasing the dividend sends a negative signal! Dividend Policies 3) Small Regular Dividend plus Year3) Small End Extras s The firm pays a stable quarterly The dividend and includes an extra yeardividend end dividend in prosperous years. s By identifying the year-end dividend By as “extra,” directors hope to avoid signaling that this is a permanent signaling dividend. dividend. Jan.4 Jan.30 Feb.1 Declare dividend Ex-div. Record date date Mar. 11 Payment date Dividend Payments 1) Declaration Date: the board of 1) Declaration directors declares the dividend, determines the amount of the dividend, and decides on the payment date. and Jan.4 Jan.30 Feb.1 Declare dividend Ex-div. Record date date Mar. 11 Payment date Dividend Payments 2) Ex-Dividend Date: 2) Ex-Dividend Jan.4 Jan.30 Feb.1 Declare dividend Ex-div. Record date date Mar. 11 Payment date Dividend Payments 2) Ex-Dividend Date: To receive the 2) Ex-Dividend dividend, 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. amount Jan.4 Jan.30 Feb.1 Declare dividend Ex-div. Record date date Mar. 11 Payment date Dividend Payments 3) Date of Record: 3) Date Jan.4 Jan.30 Feb.1 Declare dividend Ex-div. Record date date Mar. 11 Payment date Dividend Payments 3) Date of Record: 2 days after the ex3) Date dividend date, the firm receives the list of dividend stockholders eligible for the dividend. s Often, a bank trust department acts as Often, registrar and maintains this list for the firm. firm. Jan.4 Jan.30 Feb.1 Declare dividend Ex-div. Record date date Mar. 11 Payment date Dividend Payments 4) Payment Date: date on which the 4) Payment firm mails the dividend checks to the shareholders of record. shareholders Stock Dividends and Stock Splits Stock dividend: payment of additional shares of stock to common stockholders. shares s Example: Citizens Bancorporation of Citizens Maryland announces a 5% stock dividend to all shareholders of record. For each 100 shares held, shareholders receive another 5 shares. receive s Does the shareholders’ wealth increase? s Stock Dividends and Stock Splits Stock Split: the firm increases the number of shares outstanding and reduces the price of each share. price s Example: Joule, Inc. announces a 3-for-2 Example: 3-for-2 stock split. For each 100 shares held, shareholders receive another 50 shares. shareholders s Does this increase shareholder wealth? s Are a stock dividend and a stock split the Are same? same? s Stock Dividends and Stock Splits Stock Splits and Stock Dividends are Stock economically the same: the number of economically shares outstanding increases and the price of each share drops. The value of the firm does not change. does s Example: A 3-for-2 stock split is the same 3-for-2 as a 50% stock dividend. For each 100 shares held, shareholders receive another 50 shares. 50 s Stock Dividends and Stock Splits s Effects on Shareholder Wealth: Stock Dividends and Stock Splits s 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) gives shareholders 2 half-sized pieces for each full-sized piece they previously owned. full-sized Stock Dividends and Stock Splits 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) gives shareholders 2 half-sized pieces for each full-sized piece they previously owned. full-sized s For example, this would double the For number of shares, but would cause a $60 stock price to fall to $30. stock s Stock Dividends and Stock Splits Why bother? s Proponents argue that these are used to Proponents reduce high stock prices to a “more popular” trading range (generally $15 to trading $70 per share). $70 s Opponents argue that most stocks are Opponents purchased by institutional investors who have millions of dollars to invest and are indifferent to price levels. Plus, stock splits and stock dividends are expensive! expensive s Stock Dividend Example s shares outstanding: shares 1,000,000 1,000,000 s net income = $6,000,000; net $6,000,000 s P/E = 10 P/E 10 s 25% stock dividend. s An investor has 120 shares. Does the An value of the investor’s shares change? change? Before the 25% stock dividend: Before s EPS = 6,000,000/1,000,000 = $6 s P/E = P/6 = 10, so P = $60 per share. s Value = $60 x 120 shares = $7,200 Value $7,200 After the 25% stock dividend: s # shares = 1,000,000 x 1.25 = 1,250,000. s EPS = 6,000,000/1,250,000 = $4.80 s P/E = P/4.80 = 10, so P = $48 per share. s Investor now has 120 x 1.25 = 150 shares. s Value = $48 x 150 = $7,200 Value $7,200 Stock Dividends In-class Problem shares outstanding: 250,000 250,000 net income = $750,000; $750,000 stock price = $84 $84 50% stock dividend. What is the new stock price? What Hint: P/E = P/E ( stock price stock net income # shares shares ) Before the 50% stock dividend: Before s EPS = 750,000 / 250,000 = $3 EPS $3 s P/E = 84 / 3 = 28. P/E 28 After the 50% stock dividend: s # shares = 250,000 x 1.50 = 375,000. shares 375,000 s EPS = 750,000 / 375,000 = $2 EPS $2 s P/E = P / 2 = 28, so P = $56 per share. P/E $56 (a 50% stock dividend is equivalent to a (a 3-for-2 stock split) 3-for-2 Stock Repurchases s Stock Repurchases may be a good Stock substitute for cash dividends. substitute s If the firm has excess cash, why not If buy back common stock? buy Stock Repurchases s Stock Repurchases may be a good Stock substitute for cash dividends. substitute s If the firm has excess cash, why not If buy back common stock? buy Stock Repurchases s Repurchases drive up the stock Repurchases price, producing capital gains for price producing shareholders. shareholders. s Repurchases increase leverage, and Repurchases increase and can be used to move toward the optimal capital structure. optimal s Repurchases signal positive Repurchases information to the market - which information increases stock price. increases Stock Repurchases s Repurchases may be used to avoid Repurchases a hostile takeover. hostile Example: T. Boone Pickens T. attempted raids on Phillips Petroleum and Unocal in 1985. Both were unsuccessful because the target firms undertook stock repurchases. repurchases. Stock Repurchases Methods: s Buy shares in the open market Buy open through a broker. through s Buy a large block by negotiating the Buy large purchase with a large block holder, usually an institution (targeted stock repurchase). repurchase). s Tender offer: offer to pay a specific offer price to all current stockholders. price ...
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This note was uploaded on 04/15/2009 for the course FINANCE FIN 320 taught by Professor Cpirinski during the Spring '09 term at CSU Fullerton.

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