5.2 lecture_10_Thurs_13_August_2009

5.2 lecture_10_Thurs_13_August_2009 - FINC 202 2009 Lecture...

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Unformatted text preview: FINC 202 2009 Lecture 10 Dividend Policy (3) + Other Distributions to Shareholders 1 Summary of Factors influencing Summary Dividend Policy: Dividend Company law • Solvency Test Agency cost of debt in the Trade­off model of Capital Structure Restrictions in debt contracts • Capital structure of company 1. Especially if you want to change capital structure fast 2. Also affects _______________________________ Ability to raise external funding • _________________________________________ Big dividend is a drain on cash This makes servicing existing (and new) debt harder And the company becomes more risky 2 Summary of Factors influencing Summary Dividend Policy: Dividend Investment opportunities • Residual dividend policy Stability of earnings • ____________________________________________ Shareholder characteristics • Bird­in­the­hand versus Tax Preferences Clientele Theory: investors seek out companies with the dividend policy that they prefer Old people prefer regular cash instalments Young people prefer capital gains and growth of their “savings” What the competitors’ dividend policies are 3 No material past this point is testable on th 19 August 4 Topics in Lecture Dividend Imputation Share Splits Bonus Shares Share Repurchases 5 Classical system Dividend Imputation versus Classical Dividend System System • Earnings before Tax (EBT) taxed At company’s marginal tax rate EBT minus tax = NPAT • NPAT × d = __________________________ • Dividend taxed At investor’s personal marginal tax rate • Hence the dividend has been taxed TWICE First at company level Then _______________________________ 6 Dividend Imputation System Dividend is effectively only taxed once The reason is that the company: • Pays tax at company tax rate • Receives imputation credits from the IRD An accounting entry that exists on paper Company also receives Imputation Credits on ______________________________ • Company distributes dividends to investor • Company distributes imputation credits to investor Imputation credits reduce tax payable on investor’s income Tax on all of investor’s income is now at the _______________________________ 7 CLASSICAL TAXATION SYSTEM Shareholder's Marginal Tax Rate 1 COMPANY EBT Company Tax NPAT SHAREHOLDER Dividend Income Assessable Income Tax Liability Imputation Credits Net Tax Payable Shareholder Income 3 TOTAL TAX PAID Company Shareholder Total 24% $ 100.0 33.0 67.0 $ 67.0 67.0 16.1 n/a 16.1 50.9 $ 33.0 16.1 49.1 49.1% 33% $ 100.0 33.0 67.0 $ 67.0 67.0 22.1 n/a 22.1 44.9 $ 33.0 22.1 55.1 55.1% DIVIDEND IMPUTATION SYSTEM 24% $ 100.0 33.0 67.0 $ 67.0 100.0 24.0 33.0 -9.0 76.0 $ 33.0 -9.0 24.0 24% 33% $ 100.0 33.0 67.0 $ 67.0 100.0 33.0 33.0 0.0 67.0 $ 33.0 0.0 33.0 33% 2 Effective Tax Rate on Profits 8 Notes on table: 1. Shareholders only receive impuation credits if the compnay pays fully­imputed dividends. 2. Formula for grossing up: D 1 − tC Assessable Income = = New Zealand shifted from a classical system to a dividend imputation system in 1988. = . 9 Share splits firm issues m new shares for each old share eg. 2­for­1 share split One $2 share becomes two $1 shares • raises N and reduces EPS, DPS and price EPS = NPAT/N (Simplistic formulation of EPS! See extra study file in LEARN for non­examinable material on this) 10 10 Example Gamma Medical’s stock trades at $90 a share. The company is contemplating a 3­for­2 stock split. Assuming that the stock split will have no effect on the market value of its equity, What will be the company’s stock price following the stock split? 11 11 Solution to Share Split Example 12 12 Problem 1 Southern Food Ltd’s stock trades at $50 a share. The company is contemplating the following stock splits: • • • • 5:3 6:3 8:3 10:3 What would the new share price be in each instance? 13 13 5 : 3 where P0 BEFORE SPLIT = $50 Solution 1 6 : 3 where P0 BEFORE SPLIT = $50 8 : 3 where P0 BEFORE SPLIT = $50 10 : 3 where P0 BEFORE SPLIT = $50 14 14 . Share splits (2) Main motive is “optimal price range” argument • What is best price range for P0? Market often reacts favourably : • _____________________________ No cash flows involved so no wealth effects • No change to Issued Capital or RE on the Balance Sheet • Not subject to solvency test 15 15 Bonus share dividends (bonus issue) Dividend paid in additional shares • not cash eg. 1­for­1 bonus issue Costs nothing but doubles N No cash flows involved so no wealth effects • Not subject to solvency test Raises N and • reduces EPS, • Reduces dividend per share (DPS) • And _____________________________ 16 16 Bonus share dividends (2) Main motive is “optimal price range” argument Market often reacts favourably ­ “information content” Treatment in Balance sheet: • raise Issued Capital, • ________________________ 17 17 Bonus Issue Example Puddle Ltd shares currently sell at $1, which happens also to be its book value Puddle is considering issuing one bonus share for every 2 that a shareholder currenlty owns What changes occur to the balance sheet? Cash Accts. Receivable Inventory Current Assets Fixed Assets Total Assets 50,000 250,000 500,000 800,000 400,000 1,200,000 Current Liabilities Long-term Debt Total Debt Ordinary Shares Retained Earnings Total Liabilities & Equity 400,000 80,000 480,000 100,000 620,000 1,200,000 18 18 Example Solution Cash Accts. Receivable Inventory Current Assets Fixed Assets Total Assets 50,000 250,000 500,000 800,000 400,000 1,200,000 Current Liabilities Long-term Debt Total Debt Ordinary Shares Retained Earnings Total Liabilities & Equity 400,000 80,000 480,000 150,000 570,000 1,200,000 Dr Retained Earnings 50,000 Cr Ordinary Equity 50,000 19 19 Share Repurchases Equivalent to a Dividend • since cash returned to shareholders • subject to solvency test _________________________________: • Increase financial leverage and P0 • Increase EPS and P0 • • • • Return surplus cash to shareholders Protect firm from takeover Remove odd­lot holdings & small shareholders Own shares a good investment (?) Can be re­issued to managers of the firm who hold options to buy shares in the future 20 20 Dividend Impact v Buyback Impact Dividend: • • • N remains constant PEX < PBEFORE Market Value of Equity (MVEQUITY) drops________ ________________________________________. Buyback: • • N drops MVEQUITY drops but not necessarily by the original price (prior to the announcement) of the shares bought back P⇑ mitigates MV EQUITY⇓ 21 21 Buyback example: • • • NBefore = 100m PBefore = $10 MVEQUITY (Before) = $1,000m Announcement to buy back 10m shares at market value (ie 10% of shares to be bought) • Price immediately rises to $10.50 • NAfter = 90m • MVEQUITY (After) = 90m × $10.50 = $945m • Percentage drop in MV = 5.5% 22 22 Methods of Buying Back Shares There are two methods: 1. Tender Offer 2. Open Market Operation 1. Tender Offer The firm sets a price that is high enough to be attractive to shareholders. Will usually be above the current market share price. This sends a signal to investors that the company is undervalued And thus will encourage P0 to rise Ie, the share price is “talked up” The shareholders ______________________________ 23 23 1. Open market operation The firm just bids for shares as they are offered for sale on the stock exchange in normal trading. ___________________________________ The share buyback programme will still be disclosed to the Stock Exchange And thus made public to all investors The sellers trading on the exchange do not know to whom they are selling. 24 24 Advantages of Repurchases (1) A “good­news” signal that managers believe firm is undervalued • P0 ⇑ There will be fewer shares with claims on the same future NPAT and future RE • Can sell or choose not to sell • But dividends go to everybody Everybody then has to pay tax Shareholders have choice To the extent not covered by imputation credits Removal of ________________________________ No long­term target payout ratio to worry about • Target dividend payout ratio makes size of dividend “sticky” • But there is no equivalent for buybacks 25 25 Advantages of Repurchases (2) Residual dividend model can include: • Dividend per target dividend payout ratio • Plus _________________________________ Repurchase can be a tool for redesign of capital structure • See worksheet from lecture 4 Repurchased shares can be recycled • To employees with options to exercise • This avoids the dilution problem of a new issue 26 26 Disadvantages of Share Repurchases Some shareholders may prefer regular dividends • Share repurchases may not be regular or dependable Also there is a dilution problem • The more shares an investor sells back, the smaller the investor’s stake in the firm becomes… …Relative to that of other investors who do not sell shares back Selling shareholders may not be aware of the implications of selling • Firm must advertise and explain carefully in advance _________________________________ The firm might set too high a repurchase price • This hurts remaining shareholders 27 27 ...
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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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