4.2 Lecture_08_Thurs_6_Aug

4.2 Lecture_08_Thurs_6_Aug - FINC 202 2009 Lecture 08...

Info iconThis preview shows page 1. Sign up to view the full content.

View Full Document Right Arrow Icon
This is the end of the preview. Sign up to access the rest of the document.

Unformatted text preview: FINC 202 2009 Lecture 08 Dividend Policy Note 1: Most of this lecture was in the Lecture 7 slideset. Only the last 15 slides are extra Note 2: What is not covered will be rolled over into Lecture 9 1 Topics • • • Dividend Basics Dividend and the Discounted Dividend Growth Model Competing Theories of Dividend’s impact on Share Price P0 2 Basics of Dividends • • • Profit distributions to shareholders Usually paid twice­yearly Trend towards quarterly 4 key dates Declaration date Ex­dividend date Owner before and at this date gets the dividend If sold the next day, the _____________________________________ • Share price _____________________ Holder of Record Date Payment date • Pex div = Pcum div − D 3 • • • • • a) b) c) d) Problem 1: Who gets the dividend? Delaration date: 10th July Ex­div date: 10th August Holder of Record date: 12th August Payment day is 10th October • • In the computer age, this 2­day interval may be unrealistically long Assume recording ownerdhip change takes a full day Grace Buyer buys the shares via a broker from Janet Seller on: 14th August 6th August 10th August 11th August 4 • • • • Solution 1 14th August: __________________ • • Reason: ______________________________ 6th August: ___________________ Reason: ______________________________ 10th August: ___________________ • Reason: _________________________________ 11th August: ____________________ • Reason: __________________________________ 5 Must pass the Solvency Test in New Must Zealand Zealand • • • The Companies Act 1993 specifies two prerequisites: Liquidity test ­ can firm pay debts as they fall due ? Balance sheet test ­ do assets exceed liabilities ? prerequisites to be _________________________ The Act may be accessed online at: http://www.legislation.govt.nz/act/public/1993/0105/latest/DLM319570 http://www.legislation.govt.nz/act/public/1993/0105/latest/DLM319570. 6 Dividend Payout Ratio and the Dividend Discounted Dividend Growth Model Discounted D means Dividend here • • d ⇑ ⇒ D ⇑ ⇒ P0 ⇑ D1 ˆ= P0 rs − g d is the dividend payout ratio But there is a counterbalancing effect: d ⇑ ⇒ (1­d) ⇓ ⇒ ∆ RE ⇓ …. ⇒ g ⇓ ⇒ (rS – g) ⇑ ⇒ P0 ⇓ • • g = (1 – d)ROE There are TWO opposing effects But are ______________________________ • 7 1. Three competing theories Dividend Irrelevance Based on Miller and Modigliani “Dividend Policy, Growth and the Valuation of Shares” in Journal of Business October 1961 2. 3. Bird in the Hand Before MM, it was thought that a firm’s value was a function of divdends Which we see in the Discounted Dividend Model That dates from the early 1960s or late 1950s Often referred to as “the Bird in the Hand Fallacy” But it ___________________________ Tax Preference 8 Theory (1) Dividend Irrelevance Miller and Modigliani (1961) • Dividend policy has: No effect on rs No effect on P0 • Assumes: No taxes No brokerage costs • ______________________________ 9 Miller and Modigliani’s Dividend Irrelevance Miller Arithmetically Explained Arithmetically • Mellon Ltd is an all­equity company which enjoys the potential for constant growth at 10% p.a. EPS0 = $90.91 and EPS1= $100 ROE = 10% • If it consistently pays all NPAT out as dividends (ie d = 100%): g = ROE(1 ­ d) = 10% x (1 – 1) 10 10 ________________________________________ • If it pays no dividend at all (ie, d= 0%) g = ROE(1 ­ d) = 10% x (1 – 0) = 10% • • Note: rS = Dividend Yield + Capital Gains Yield This implies: CGY = 0 when DivY = rS =10% DivY = 0 when CGY = g = rS __________________ 11 11 Let Mellon Ltd pay 100% of NPAT as dividends every Let period forever period D1 D1 P0 = = rS − 0 rS D1 $100 = = $1, 000 rS 0.10 • Now let D1 = $0 and D2 onward = _____________ P= 1 Constant growth model after one period of non­constant growth D2 110 = = $1,100 rS − 0 0.1 And D1 P P0 = +1 1 + rS 1 + rS 0 $1,100 + 1.1 1.1 = $1000 = 12 12 Problem 2 • What if Mellon Ltd chooses to pay no dividends for 6 years. Then from year 7, 100% of NPAT is paid out as a dividend each year forever. Show that the intrinsic value of a share is still $1,000. 13 13 Solution 2 14 14 Some Caveats • There are some hidden assumptions in this model: Do the firm’s existing projects _________________________________________ If new Capex is necessary, how is it funded? • Debt? • New issues of Equity? • Model assumes that rE = rS But rE > rS because flotation costs > 0 • More generally, however, the MM argument is stated in terms of the following slide Which does not require that d = 0% or 100% 15 15 More generally, on dividend irrelevance: Higher payout ratio (d) • Rise in D1 exactly offsets rise in (rs­g) higher payout ratio rise in current dividend income fall in reinvestment fall in future capital gains shareholder wealth unchanged 16 16 General Case on Dividend Irrelevance: Lower payout ratio (d) • Fall in D1 exactly offsets fall in (rs­g) lower payout ratio fall in current dividend income rise in reinvestment rise in future capital gains shareholder wealth unchanged 17 17 Dividend Irrelevance Conclusions: • shareholders should be indifferent to dividend policy • • reduction in dividend should not depress share price shareholders can create home­made dividends alternative to a dividend cut is a new share issue NB. Implicit assumptions: zero transaction and issue costs no taxes _________________________________________ • This is a reference to Dividend signalling Theory 18 18 Theory (2) Theory Bird-in-the-hand Bird-in-the-hand • Investors prefer dividends over capital gains d ⇑ ⇒ D ⇑ and rs ⇓ rs ⇓ balances g ⇓ in denominator of: And ________________ D1 P0 = rs − g 19 19 Theory (3) Theory Tax Preference Tax • Dividends taxed more highly than capital gains Investors will prefer capital gains • Because they can defer realising them d ⇑ ⇒ D ⇑ and rs ⇑ • That rS ⇑ AND g ⇓ ⇒ (rS – g) ⇑ ⇑ And ______________ D1 P0 = rs − g 20 20 • • Tests are inconclusive Which theory is right? No clear relationship between • Dividend policy and rs Common belief was that dividends determined the value of the firm. Prior to Miller and Modigliani (1961) Even long before Gordon (1959) and the discounted Dividend Model • Therefore firms thought they should have a high dividend payout ratio The MM paper blew this consensus apart. • And opened up almost 50 years of debate. Different firms choose different dividend policies • And d ranges from ______________________________________________ 21 21 • Today: No clear consensus Dividend Signalling Theory • Share prices change in response to the announcement by firms of: • Therefore dividend announcements signal information to investors Initiation of Dividends P0⇑ Increase in size of Dividends • _________________________________ Reduction in size of Dividends • P0⇓ Omission of Dividends • __________________________________ About the firm’s future prospects • ___________________________________ 22 22 Signalling Theory: • The important variable is called “Abnormal Return” (AR) Constructed from returns • Daily …or • Weekly …or • Monthly Measuring Dividend Signals Measuring Pt − Pt −1 R jt = Pt −1 Indext − Indext −1 RMt = Indext −1 or... Pt R jt = ln Pt −1 Indext RMt = ln Indext −1 or... 23 23 • An estimation period of (say!) 100 days is used to get an estimate of E(R) Statistical Method = Simple regression of 100 observations of Rjt on RMt The values of the parameters______________________. • Use Rjt and RMt from the Test Period in conjunction with _________________________________________ R jt = α j + β j RMt + ε jt E(R) for any given day t is the right­hand side without the error term 24 24 Regression estimation period Forecast into this Period t­110 t­10 t0 t10 AR jt = R jt − E ( R jt ) Where : E ( R jt ) = α + β RMt This is called the Test Period 25 25 NZ data 1990-1999 ARs associated with announcement of Increased Dividends AND Increased Earnings Increased 0.0200 0.0150 0.0100 0.0050 0.0000 -0.0050 -0.0100 -0.0150 -0.0200 ARt-10 ARt-9 ARt-8 ARt-7 ARt-6 ARt-5 ARt-4 ARt-3 ARt-2 ARt-1 ARt0 ARt1 ARt2 ARt3 ARt4 ARt5 ARt6 ARt7 ARt8 ARt9 ARt10 26 26 ARs statistically significant at the 5% level of error are circled NZ data 1990-1999 ARs associated with announcement of Decreased Dividends AND Decreased Earnings Decreased 0.0200 BAD NEWS CASE 0.0150 0.0100 0.0050 0.0000 -0.0050 -0.0100 -0.0150 -0.0200 ARt-10 ARt-9 ARt-8 ARt-7 ARt-6 ARt-5 ARt-4 ARt-3 ARt-2 ARt-1 ARt0 ARt1 ARt2 ARt3 ARt4 ARt5 ARt6 ARt7 ARt8 ARt9 ARt10 Day zero (t0) ARs statistically significant at the 5% level of error are circled 27 27 What these diagrams say in terms of What share prices: GOOD NEWS CASE share Pt in $ t0 Good news case Time 28 28 What these diagrams say in terms of What share prices: BAD NEWS CASE share Pt in $ t0 Bad news case Time 29 29 Dividend Behaviour of Firms • • Lintner (1956) studied dividend behaviour of US firms John Lintner, “Distribution of Incomes of corporations among Dividends, Retained Earnings, and Taxes” American Economic Review Vol 46, May 1956 Four major findings: Firms have long­run _______________________________________________ This ties in with Capital Structure and WACC See Problem 3 on next slide These interlock with each other Managers focus more on dividend changes than on ____________________________________________ Firms reluctant to make dividend changes that might have to be reversed Dividend changes follow shifts in long­run sustainable earnings 30 30 Problem 3 Yolanda Skateboards forecasts the following information for next year: • • • • • • • • • • NPAT = $4 m Dividend payout ratio d = 40% Weighting of equity wS = 25% D1 = $1 P0 =$20 g =5% rRF = 6% = 1 β rM =10% Flotation costs are super expensive at 10% of the share price Required: (a) What is the BPEQUITY with when d = 40% ? (b) What is the cost of equity, rS when d = 40% (c) What is the new BPEQUITY if d = 60% ? (d) What is the cost of new equity rE if d = 60% 31 31 ∆RE NPAT × ( 1 − d ) BP = = ws ws = Solution 3 rS = rRF + β ( rM − rRF ) = = = OR... D1 rS = +g P0 = 32 32 . BP = ∆RE ws . Solution 3 page 2 = D1 rE = +g P0 ( 1 − F % ) = = 33 33 . Two Effects of a rise in Dividend Payout Two Ratio “d” on WACC Schedule Ratio WACC WACC0 BPEQUITY 0 $$ 34 34 ...
View Full Document

Ask a homework question - tutors are online