Chapter 18 Dividends and Dividend Policy 0
0 Chapter 18 Dividends and Dividend Policy
Chapter Outline Cash Dividends and Dividend Payment Does Dividend Policy Matter? Establishing a Dividend Policy Stock Repurchase:An Alternative to Cash Dividends Stock Dividends and Stock Splits
1 Chapter Outline n Cash Dividends and Dividend Payment n Does Dividend Policy Matter? n Establishing a Dividend Policy n Stock Repurchase: An Alternative to Cash Dividends n Stock Dividends and Stock Splits
Key Concepts and Skills Understand dividend types and how they are paid Understand the issues surrounding dividend policy decisions Understand the difference between cash and stock dividends Understand why share repurchases are an alternative to dividends 2
2 Key Concepts and Skills n Understand dividend types and how they are paid n Understand the issues surrounding dividend policy decisions n Understand the difference between cash and stock dividends n Understand why share repurchases are an alternative to dividends
Cash Dividends Regular cash dividend-cash payments made directly to stockholders,usually each quarter Extra cash dividend -indication that the "extra" amount may not be repeated in the future Special cash dividend -similar to extra dividend,but definitely won't be repeated Liquidating dividend-some or all of the business has been sold
3 Cash Dividends n Regular cash dividend – cash payments made directly to stockholders, usually each quarter n Extra cash dividend – indication that the “extra” amount may not be repeated in the future n Special cash dividend – similar to extra dividend, but definitely won’t be repeated n Liquidating dividend – some or all of the business has been sold
Dividend Payment Declaration Date-Board declares the dividend and it becomes a liability of the firm Ex-dividend Date Occurs two business days before date of record If you buy stock on or after this date,you will not receive the upcoming dividend Stock price generally drops by approximately the amount of the dividend Date of Record -Holders of record are determined,and they will receive the dividend payment Date of Payment-checks are mailed
4 Dividend Payment n Declaration Date – Board declares the dividend and it becomes a liability of the firm n Ex-dividend Date q Occurs two business days before date of record q If you buy stock on or after this date, you will not receive the upcoming dividend q Stock price generally drops by approximately the amount of the dividend n Date of Record – Holders of record are determined, and they will receive the dividend payment n Date of Payment – checks are mailed
Figure 14.2 The Ex-Day Price Drop Ex date +1+2。。。t Price=$10← t。。。-2-10 $1 is the ex-dividend price drop >Price $9 The stock price will fall by the amount of the dividend on the ex date (Time 0).If the dividend is $1 per share,the price will be equal to $10-1 $9 on the ex date. Before ex date(Time-1) Dividend $0 Price $10 On ex date (Time 0) Dividend =$1 Price $9 5
5 Figure 14.2 The Ex-Day Price Drop
Does Dividend Policy Matter? Dividends matter-the value of the stock is based on the present value of expected future dividends Dividend policy may not matter o Dividend policy is the decision to pay dividends versus retaining funds to reinvest in the firm In theory,if the firm reinvests capital now,it will grow and can pay higher dividends in the future 6
6 Does Dividend Policy Matter? n Dividends matter – the value of the stock is based on the present value of expected future dividends n Dividend policy may not matter q Dividend policy is the decision to pay dividends versus retaining funds to reinvest in the firm q In theory, if the firm reinvests capital now, it will grow and can pay higher dividends in the future
Illustration of Irrelevance ■ Consider a firm that can either pay out dividends of $10,000 per year for each of the next two years, or can pay $9,000 next year,reinvest the other $1,000 into the firm,and then pay $11,120 next year.Investors require a 12%return. Market Value with constant dividend $16,900.51 Market Value with reinvestment $16,900.51 If the company will earn the required return,then it doesn't matter when it pays the dividends
7 Illustration of Irrelevance n Consider a firm that can either pay out dividends of $10,000 per year for each of the next two years, or can pay $9,000 next year, reinvest the other $1,000 into the firm, and then pay $11,120 next year. Investors require a 12% return. q Market Value with constant dividend = $16,900.51 q Market Value with reinvestment = $16,900.51 n If the company will earn the required return, then it doesn’t matter when it pays the dividends
Low Payout Please Why might a low payout be desirable? Individuals in upper income tax brackets might prefer lower dividend payouts,with their immediate tax consequences,in favor of higher capital gains Flotation costs-low payouts can decrease the amount of capital that needs to be raised,thereby lowering flotation costs Dividend restrictions -debt contracts might limit the percentage of income that can be paid out as dividends 8
8 Low Payout Please n Why might a low payout be desirable? n Individuals in upper income tax brackets might prefer lower dividend payouts, with their immediate tax consequences, in favor of higher capital gains n Flotation costs – low payouts can decrease the amount of capital that needs to be raised, thereby lowering flotation costs n Dividend restrictions – debt contracts might limit the percentage of income that can be paid out as dividends
High Payout Please Why might a high payout be desirable? Desire for current income Individuals in low tax brackets Groups that are prohibited from spending principal(trusts and endowments) Uncertainty resolution-no guarantee that the higher future dividends will materialize Taxes Dividend exclusion for corporations Tax-exempt investors don't have to worry about differential treatment between dividends and capital gains 9
9 High Payout Please n Why might a high payout be desirable? n Desire for current income q Individuals in low tax brackets q Groups that are prohibited from spending principal (trusts and endowments) n Uncertainty resolution – no guarantee that the higher future dividends will materialize n Taxes q Dividend exclusion for corporations q Tax-exempt investors don’t have to worry about differential treatment between dividends and capital gains