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Chapter 16 - Dividend Policy “Finance is the art of...

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464 Dividend Policy Finance is the art of passing currency from hand to hand until it finally disappears.” —Robert W. Sarnoff GM Cuts Its Dividend On February 7, 2006, General Motors (GM) announced that it was cutting its common stock dividend by 50%. This move would save the company $565 million per year in cash. The company had been bleeding red ink on its income statement for years, losing $8.6 billion in 2005 alone. Dividends use up cash. A company such as General Motors needs to turn a profit if it hopes to grow its dividends over the long haul. In early 2006 GM had a lot of cash on its balance sheet but its losses were draining that cash. In this chapter we examine how dividends are related to profits and to cash. GM’s dividend cut is a symptom of its more fundamental financial problems. It will need to address those fundamental problems if it hopes to get its dividends back to the levels its investors have grown to expect over the years. Sources : http://www.foxnews.com/story/0,2933,184088,00.html , 6/11/06 http://www.msnbc.msn.com/ id/11275908/ ,6/11/06.
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465 © PhotoEuphoria ( http://www.fotolia.com/p/4165 ) Learning Objectives After reading this chapter, you should be able to: 1. Explain the importance of and identify factors that influence the dividend decision. 2. Compare the major dividend theories. 3. Describe how a firm pays dividends. 4. Identify alternatives to paying cash dividends. Chapter Overview In this chapter we explore the importance of dividends, the factors that determine a firm’s dividend policy, and leading dividend policy theories. We then examine how a firm makes dividend payments to shareholders. We finish by identifying alternatives to paying cash dividends. Dividends Dividends are the cash payments that corporations make to their common stockholders. Dividends provide the return common stockholders receive from the firm for the equity capital they have supplied. 1 Companies that do not currently pay dividends reinvest in the firm the earnings they generate. In this way they increase the ability of the firm to pay dividends in the future. The board of directors decides what dividend policy best serves the common stockholders of the firm. Should a dividend be paid now, or should the earnings generated be reinvested for the future benefit of the common stockholders? If dividends are paid now, how much should be paid? These are some of the questions addressed in the following sections. 1 You may wonder about this statement because common stock investors can always receive a return by selling their stock. Remember, however, that when investors sell their stock they are paid by other investors, not by the corporation. Except when a corporation buys back its own stock (which is a form of dividend payment), the only cash corporations pay to investors is a dividend payment.
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466 Part IV Long-Term Financing Decisions Although only corporations officially pay dividends to owners, sole proprietorships and partnerships also distribute profits to owners. Many of the same considerations
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