FM8e- ch16 - 16 1 Distributions to Shareholders Dividends...

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16 - 1 CHAPTER 16 Distributions to Shareholders: Dividends and Repurchases Theories of investor preferences Signaling effects Residual model Dividend reinvestment plans Stock dividends and stock splits Stock repurchases
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16 - 2 What is “dividend policy”? It’s the decision to pay out earnings versus retaining and reinvesting them. Includes these elements: 1. High or low payout? 2. Stable or irregular dividends? 3. How frequent? 4. Do we announce the policy?
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16 - 3 Dividend Payout Ratios for Selected Industries Industry Payout ratio Banking 38.29 Computer Software Services 13.70 Drug 38.06 Electric Utilities (Eastern U. S.) 67.09 Internet n/a Semiconductors 24.91 Steel 51.96 Tobacco 55.00 Water utilities 67.35 *None of the internet companies included in the Value Line Investment Survey paid a dividend.
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16 - 4 Do investors prefer high or low payouts? There are three theories: Dividends are irrelevant: Investors don’t care about payout. Bird-in-the-hand: Investors prefer a high payout. Tax preference: Investors prefer a low payout, hence growth.
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16 - 5 Dividend Irrelevance Theory Investors are indifferent between dividends and retention-generated capital gains. If they want cash, they can sell stock. If they don’t want cash, they can use dividends to buy stock. Modigliani-Miller support irrelevance. Theory is based on unrealistic assumptions (no taxes or brokerage costs), hence may not be true. Need empirical test.
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16 - 6 Bird-in-the-Hand Theory Investors think dividends are less risky than potential future capital gains, hence they like dividends. If so, investors would value high payout firms more highly, i.e., a high payout would result in a high P 0 .
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Tax Preference Theory Retained earnings lead to capital gains, which are taxed at lower rates than dividends: 28% maximum vs. up to 38.6%. Capital gains taxes are also deferred . This could cause investors to
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This note was uploaded on 08/29/2009 for the course FM Finance taught by Professor Unknown during the Spring '09 term at DeVry Addison.

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FM8e- ch16 - 16 1 Distributions to Shareholders Dividends...

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