FIN 620-session 10 lecture

FIN 620-session 10 lecture - FIN 620 Long-Term Financial...

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FIN 620 Long-Term Financial Management Session 10  1. Lecture Notes/Comments Having considered financing and its effect on value in the earlier sessions, in this session we now turn our attention to payouts made to investors ( chapter 19 ). For equity investors this is generally in the form of dividends, but can also be in the form of a share repurchase. An important question in corporate finance is what are the reasons why firms pay dividends? Dividends are a form of anti-financing; that is, they return money to investors rather than receiving money. Carrying over the MM logic from financing would suggest that dividend policy is irrelevant, but is it really so in the real world? We discuss some theories of dividends. In the second half of this session ( Chapter 29 ) we present some issues involved in dealing with mergers and acquisitions. A good question to ponder is: Can the wrong dividend policy bankrupt a firm? The following anecdote suggests that dividend policy can play a role in a company’s downfall. The automobile industry was quite prosperous in the 1920s, but was hit hard by the depression. Studebaker Corporation, which was relatively weak to begin with, suffered more than other automotive manufacturers. Part of the reason for its financial problems was the belief by the firm’s president that dividends alone could increase the value of the stock. He implemented a dividend policy that increased the dividend payout ratio from 43 percent in the early 1920s to 91 percent in 1929. However, the dividend was held constant in 1930 and 1931, even as sales and earnings decreased. This led to a payout ratio of 500 percent (!) in 1930 and 350 percent in 1931. In 1932, the company lost $8.7 million, but still paid $1 million in dividends! The firm’s financial health was damaged significantly by the generous dividend policy, and it filed for reorganization in March, 1933. Tragically, the firm’s president took it very personally and shot himself three months later. Different Types of Dividends 1. Regular cash dividend – normal dividends, usually paid on a quarterly basis. Extra cash dividend – paid over and above the regular dividend, may or may not be repeated.
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2. Special dividend – one-time dividend paid over and above the regular dividend, will not be repeated. 3. Stock dividend – pay owners with additional shares of stock. No cash actually leaves the firm. Dividends in kind – pay owners using products or services of the firm Standard Method of Cash Dividend Payment: 1. Declaration date – the dividend is declared by the Board of Directors and becomes a liability of the firm 2. Ex-dividend date – occurs 2-3 days prior to the date of record; if you purchase the stock on or after the ex-dividend date, you will not receive the dividend 3. Date of record – firm prepares the list of stockholders who will receive dividends 4. Date of payment – checks are mailed The stock price drops by approximately the amount of the dividend on the ex-
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FIN 620-session 10 lecture - FIN 620 Long-Term Financial...

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