Stockholder Characteristics A firm whose stockholders like dividends will

Stockholder characteristics a firm whose stockholders

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Stockholder Characteristics: A firm whose stockholders like dividends will generally pay a much higher proportion of its earnings as dividends than will one without such stockholders. 3.3 Framework for Analyzing Dividend Policy In applying a rational framework for analyzing dividend policy, a firm will attempt to answer two questions: 1. How much cash is available to be paid out as dividends, after meeting capital expenditure and working capital needs to sustain future growth, and how much of this cash is paid out to stockholders? 2. How good are the projects that are available to the firm? In general, firms that have good projects will have much more leeway on dividend policy, since stockholders will expect that the cash accumulated in the firm will be invested in these projects and
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114 eventually earn high returns. By contrast, firms that do not have good projects will find themselves under pressure to pay out all of the cash that is available as dividends. 3.3.1. How much can a firm pay out or return Shareholders To estimate how much cash a firm can afford to return to its stockholders, we begin with the net income – the accounting measure of the stockholders earnings during the period – and convert it to a cash flow as follows. First, any capital expenditures are subtracted from the net income, because they represent a cash outflow, Depreciation, on the other hand, is added back in because it is a noncash charge. The difference between capital expenditures and depreciation is referred to as net capital expenditures and is usually a function of the growth characteristics of the firm. High –growth firms tend to have net capital expenditures relative to earnings, whereas low – growth firms tend to have high net capital expenditure (because depreciation is offset by capital expenditures). Second, since increases in working capital drain a firm’s cash flows. While decreases in working capital increase the cash flows available to equity investors, firms that are growing fast, in industries with high working capital. Because we are interested in the cash – flow effects, we consider only 3.3.2 What kind of Projects Does the firms have? The alternative to returning cash to stockholders is reinvesting the funds back into the firm. Consequently, a firm’s investment opportunities provide another dimension for analyzing dividend policy. Other things remaining equal, a firm will better projects typically has more flexibility in setting dividend poly and defending it against stockholders. 3.3.3 Poor Projects and Low Pay Out In this section, we examine the consequences of paying out much less in dividends than a firm has available in cash flows, while facing poor investment opportunities. We also discuss stockholder reaction and management response to the dividend policy.
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