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5.1.1 Rest_of_Lecture_09_in_full._2009

5.1.1 Rest_of_Lecture_09_in_full._2009 - Slides not covered...

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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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