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CHAPTER. 18. Dividends and Other Payouts. Different Types of Dividends. Cash dividend Stock dividends Dividend in kind Wrigley’s Gum sends around a box of chewing gum. Dundee Crematoria offers shareholders discounted cremations. Stock repurchases. Procedure for Cash Dividend Payment.

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  1. CHAPTER 18 Dividends and Other Payouts

  2. Different Types of Dividends • Cash dividend • Stockdividends • Dividend in kind • Wrigley’s Gum sends around a box of chewing gum. • Dundee Crematoria offers shareholders discounted cremations. • Stock repurchases

  3. Procedure for Cash Dividend Payment 25 Oct. 1 Nov. 2 Nov. 6 Nov. 7 Dec. … Ex-dividend Date Declaration Date Cum-dividend Date Record Date Payment Date Declaration Date: The BOD declares a payment of dividends. Cum-Dividend Date: The last day that the buyer of a stock is entitled to the dividend. Ex-Dividend Date: The first day that the seller of a stock is entitled to the dividend. Record Date: The corporation prepares a list of all individuals believed to be stockholders as of …

  4. Price Behavior around the Ex-Dividend Date • In a perfect world, the stock price will fall by the amount of the dividend on the ex-dividend date -t … -2 -1 0 +1 +2 … $P $P - div The price drops by the amount of the cash dividend- AT Ex-dividend Date Empirically, the price drop is less than the dividend and occurs within the first few minutes of the ex-date.

  5. Irrelevance of Dividend Policy • MM argue that the value of the firm is determined only by its basic earning power and its business risk • Dividend policy will have no impact on the value of the firm because investors can create whatever income stream they prefer by using homemade dividends • To get the same results, we need to assume no taxes (in US 15%), no transaction costs and no uncertainty • Since capital gains can be deferred, the effective rate on dividends is greater than capital gains

  6. Homemade Dividends • Bianchi Inc. is a $42 stock about to pay a $2 cash dividend. • Bob Investor owns 80 shares and prefers $3 cash dividend. • Bob’s homemade dividend strategy: • Sell 2 shares ex-dividend homemade dividends Cash from dividend $160 Cash from selling stock $80 Total Cash $240 Value of Stock Holdings $40 × 78 = $3,120 $3 Dividend $240 $0 $240 $39 × 80 = $3,120

  7. Dividend Policy is Irrelevant Bob began with total wealth: $3,360 = 80 shares * $42/share After a $3 dividend total wealth: 80 shares * $39/share + $240 = $3,360 After a $2 dividend & sale of 2 ex-div shares total wealth: 78 shares * $40/share + $160 + $80 = $3,360 Note: Does not take into account transaction costs or taxes

  8. Share Repurchase • Lower tax (but the IRS is watching) • Tender offers • If offer price is set wrong, some stockholders lose. • Open-market repurchase • Targeted repurchase • Greenmail • Repurchase as investment • Recent studies has shown that the long-term stock price performance of securities after a buyback is significantly better than the stock price performance of comparable companies that do not repurchase.

  9. Assets Liabilities & Equity A. Original balance sheet Cash $150,000 Debt 0 Other assets 850,000 Equity 1,000,000 Value of Firm 1,000,000 Value of Firm 1,000,000 Shares outstanding 100,000 = Price per share $1,000,000 /100,000 = $10 = Stock Repurchase versus Dividend The firm would like to distribute $100,000 to its shareholders

  10. Assets Liabilities s & Equity B. After $1 per share cash dividend Cash $50,000 Debt 0 Other assets 850,000 Equity 900,000 Value of Firm 900,000 Value of Firm 900,000 Shares outstanding g = 100,000 Price per share = $900,000/1 00,000 = $9 Stock Repurchase versus Dividend If they distribute the $100,000 as cash dividend, the balance sheet will look like this:

  11. Assets Li abilities & Equity C. After stock repurchase Cash $50,000 Debt 0 Other assets 850,000 Equity 900,000 Value of Firm 900,000 Value of Firm 900,000 Shares outstanding = 90,000 Price per share = $900,000 / 90,000 = $10 Stock Repurchase versus Dividend If they distribute the $100,000 through a stock repurchase, the balance sheet will look like this:

  12. Firms With Sufficient Cash toPay a Dividend • Consider a firm that has $1 million in cash after selecting all available positive NPV projects. • The firm has several alternative options: • Select additional capital budgeting projects (by assumption, these are negative NPV). • Acquire other companies • Purchase financial assets • Repurchase shares

  13. Real World Factors • Reasons for Low Dividend • Personal Taxes • High Issuing Costs • Reasons for High Dividend • Information Asymmetry • Dividends as a signal about firm’s future performance • Lower Agency Costs • Capital market as a monitoring device • Reduce free cash flow, and hence wasteful spending • Bird-in-the-hand: Theory or Fallacy? • Uncertainty resolution • Desire for Current Income

  14. The Clientele Effect: A Resolution of Real-World Factors? • Clienteles for various dividend payout policies are likely to form in the following way: Group Stock High Tax Bracket Individuals Zero to Low payout stocks Low Tax Bracket Individuals Low-to-Medium payout Tax-Free Institutions Medium Payout Stocks Corporations High Payout Stocks Once the clienteles have been satisfied, a corporation is unlikely to create value by changing its dividend policy.

  15. What We Know and Do Not Know About Dividend Policy • Corporations “Smooth” Dividends. • Dividends Provide Information to the Market. • Firms should follow a sensible dividend policy: • Don’t forgo positive NPV projects just to pay a dividend. • Avoid issuing stock to pay dividends. • Consider share repurchase when there are few better uses for the cash.

  16. #1- Irrelevance of Dividends Benco, Inc. has 2 million shares currently outstanding at $15 per share. The company declares at 50% stock dividend. How many shares will be outstanding after the dividend is paid? After the stock dividend, what is the new price per share and the new value of the firm?

  17. #2 Company Policies Look at the dividends for each of the following company’s over the last five years and discuss why they would each have such different dividend policies: US Steel (X), Dow Chemical (DOW) and Micron Technology (MU)

  18. #3 – Stock Splits and Dividends Company ABC has 10,000 shares of stock selling at $60 per share. The company is considering either a stock dividend of 10% or a 3-for-1 stock split. Which one would have the greatest impact on the owner’s equity? Assume the following is their balance sheet prior to any announcements: Common stock (par $12) $120,000 Capital in excess of par $200,000 Retained Earnings $180,000 Total owner’s equity $500,000

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