Unformatted text preview: Slides not covered in Lecture 09 Slides that you need to cover for this week’s tutorials and for the test. week’s 1 c. Dividend policy as the residual ? Dividend = ∆Debt + NPAT + Shares NEW − Investment
Steps in setting dividend: determine optimal capital budget determine amount of debt & equity required use RE to supply equity component (supplement by share issue if required) pay dividends if surplus funds remain 2 This amounts to: Target Dividends = Net Income  equity ratio Total E = NPAT − × capital TA budget Total × capital budget 3 Example of residual dividend policy
Assumptions: Firm is funded by debt and ordinary equity only Target debt ratio = wd = 40% (infer equity ratio from this) Forecasted NPAT = $60m Three possible levels of investment:
• low: $40m • medium: $70m • high: $150m We are ALWAYS looking into the future and NOT the past 4 (i) Investment Budget = $40m
∆ Debt required = 0.4 x $40m = $16m Debt required = 0.4 x $40m = $16m ∆ Equity required = 0.6 x $40m = $24m Equity required = 0.6 x $40m = $24m NPAT1 > ∆ Equity so New Shares = 0 Equity so New Shares = 0 D1 = ∆ Debt +NPAT1 + SharesNEW Inv Equity Ratio (E/TA) = $16m + $60m + $0m $40m = $36m d = $36m/$60m = 0.60 or 60% Total E Dividends = NPAT  × capital TA budget = 60m − 0.6 × ( 40m ) = 36m
5 (ii) Investment Budget = $70m ∆ Debt required = 0.4 x $70m = $28m Debt required = 0.4 x $70m = $28m ∆ Equity required = 0.6 x $70m = $42m Equity required = 0.6 x $70m = $42m NPAT1 > ∆ Equity so New Shares = 0 Equity so New Shares = 0 D1 = ∆ Debt +NPAT1 + SharesNEW – Inv = $28m + $60m + $0m $70m = $18m d = $18m/$60m = 0.30 or 30% Total E Dividends = NPAT  × capital TA budget = 60m − 0.6 × ( 70m ) = 18m
6 (iii) Investment Budget = $150m
∆ Debt required = 0.4 x $150m = $60m Debt required = 0.4 x $150m = $60m ∆ Equity required = 0.6 x $150m = 90m Equity required = 0.6 x $150m = 90m NPAT1 < ∆ Equity so New Shares = $30m D1 = ∆ Debt +NPAT1 + SharesNEW – Inv =$60m + $60m + $30m $150m =$0m d = $0m/$60m = 0.0 or 0% Total E Dividends = NPAT  × capital TA budget = 60m − 0.6 × ( 150m ) = −30m
7 A firm’s next NPAT expected to be $50m Target capital structure:
• • Problem 2 Optimum capital budget = $60m wd = 30% and wS = 70% Required: With respect to the residual dividend policy:
1. What is the total amount of dividends to be paid and the value of “d” ? 2. If the optimum capital budget = $100m, what is “d” and what must be raised in new shares? 1. If the optimum capital budget = $100m and NPAT = $80m, what is paid out in dividends and what is “d”?
8 Solution 2 (c) Total E Dividends = NPAT  × capital TA budget = = Div d= = NPAT . .
9 Solution 2 Total E Dividends = NPAT  × capital TA budget = = d= Div = NPAT (a) and (b) Dividends =
. = = d= Div = NPAT
10 10 . Conclusions on Residual Dividend Policy Payout ratio fluctuates with NPAT and Investment budget.
• Fluctuations are considered bad… …if investors believe dividends perform a signalling function Therefore dividend smoothed around longrun target payout ratio
Lintner (1956) • (eg. 50%) over medium term • shortrun deviations from optimal investment/financing 11 11 policies tolerated Example: low NPAT1 and high Investment Example: low NPAT The firm does a compromise:
• Payout ratio allowed to fall below target level But not to the full extent possible Tolerated temporarily • Debt ratio is allowed to rise above target level But not to the full extent possible Tolerated temporarily • Some projects delayed/cancelled
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 Spring '09
 WarwickAnderson
 Dividend, TA, residual dividend policy, capital TA

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