5.1.1 Rest_of_Lecture_09_in_full._2009

5.1.1 - 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

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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 12 12 ...
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This note was uploaded on 12/23/2009 for the course BCOM FINC 202 taught by Professor Warwickanderson during the Spring '09 term at Canterbury.

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