Chapter 14
Which of the following involves a firm distributing stock instead of cash to its owners?
-A stock dividend -A stock split
A stock dividend will result in which of the following?
-An increase in shares outstanding -A decrease in the value per share
A reverse stock splits results in:
-An investor owning fewer shares -A higher share price
In the United States, dividends have historically been taxed at ___ rate compared with capital gains.
A Higher
A stock dividend is not a true dividend because:
It is not paid in cash (Stock dividends are also expressed as percentages)
According to a recent survey, the highest priority for financial managers is to:
Maintain a consistent dividend policy
Which of the following are factors which favor a low dividend payout?
-Bond covenant restrictions -Flotation costs -Tax laws
Which of the following is true about stock dividends and stock splits?
-Both will reduce the share price -Both will increase the total number of shares
Dividend Types
-Cash Dividends -Stock Dividends ~Gives additional shares of stock to existing shareholders of the firm
Stock Repurchase
-Company buys back its own shares of stock ~Tender offer =Company states a purchase price and a desired number of shares to be purchased ~Open market =Buys stock in the open market from broker -Similar to a cash dividend in that it returns cash from the firm to the stockholders -This is another argument for dividend policy irrelevance in the absence of taxes or other imperfections
A firm can pay out its cash earnings to its shareholders in which of the following ways?
-Dividends -Share Repurchase
Dividends received by shareholders can be expressed in which of the following ways?
-Dividends payout -Dividend yield -Dividends per share
Information Content of Dividends
-Firm can change the dividend without changing its pay out policy, but can still cause the stock price to change -Stock prices generally rise with UNEXPECTED increases in dividends and fall with UNEXPECTED decreases in dividends -Tend to not increase dividends unless they are very sure that the company can continue to sustain the higher dividend amount in the future -Does this mean that the average investor prefers a high dividend payout ratio? ~ NO ~ Changes in the dividend send a signal about management's view concerning future prospects
Which of the following are true relative to dividends?
-Investors will view a dividend cut as bad news -Dividend stability is important -Dividend increases tend to lag earnings increases
A firm which pays cash dividends is signaling ___ and ___.
-It is not hoarding too much cash -It expects to continue to be profitable
Low Payout Desirability
-Low dividend payout means more money is being reinvested into the company -Higher retention ratio = higher growth rate -Dividends growing = stock price increasing -Individuals in upper income tax brackets might prefer lower dividend payouts (stock price goes up), with the 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
Information Content of Stock Repurchases
-Stock repurchases sends a positive signal that management believes that the current stock price is low and should be higher than it is -Tender offers send a more positive signal than open market repurchases because the company is stating a specific price -The stock price often increases when repurchases are announced
Stock Splits
-Stock splits ~Essentially the same as a stock dividend except expressed as a ratio =For example, a 2 for 1 stock (2 new shares for every one old share you own) split is the same as a 100% stock dividend -Stock price is reduced when the stock splits, so total value of the firm will be the same -Common explanation for split is to return price to a "more desirable trading range" (boosting the demand of the stock) ~i.e. Apple
Accounting for the time value of money, which of the following is true of an increase in dividend payout at a point in time?
-The net effect is zero -It is exactly offset by a decrease somewhere else
A company may consider a reverse stock split for which of the following reasons?
-To increase the share price to a "respectable" level -To meet exchange listing requirements -To increase liquidity -To reduce transaction costs to investors
Which of the following are reasons why investors might favor a high dividend payout?
-Transaction costs for selling low dividend stocks can be avoided -Stock sales are time consuming -A preference for current income
Implications of the Clientele Effect
-What do you think will happen if a firm changes its policy from a high payout to a low payout? ~balance between supply and demand changes (price changes) -What do you think will happen if a firm changes its policy from a low payout to a high payout? ~balance between supply and demand changes (price changes) -If this is the case, does dividend POLICY matter? ~if price changes because the dividend policy changes, then it must be important
In 2010, 80% of the aggregate dividends from US companies were paid by:
100 Large firms
The date on which the company's Board of Directors passes a resolution to pay a dividend is called the ___ date.
Declaration
In order to receive a dividend, a stockholder must purchase stock before a certain date. That date is called the ___.
Ex-Dividend Date
(T/F) Dividends are irrelevant.
False
Residual Dividend Policy Example GIVEN: -Need $5 million for new investments -Target capital structure: D/E=2/3 (2 portions financed with debt, 3 portions financed with equity) -Net Income = $4 million
Finding Dividend: -40% financed w/ debt (2 mill) -60% financed w/ equity (3 mill) -Net Income - Equity Financing = $1 million, paid out as dividends
According to a recent survey, which of the following is of very little importance to managers in setting dividend policy?
Flotation costs to issue new equity
To a tax-paying stockholder, a stock repurchase ___.
Has significant tax advantages compared to a cash dividend
Repurchasing Stock
Instead of paying dividend to all stock holders, it would repurchase some stock from some of the stockholders and give no cash to the other shareholders
The crux of dividend policy is whether the firm should pay out money to its shareholders or take that money and:
Invest it for shareholders
When a firm authorizes a trustee to repurchase shares as they become available, they are using an ___ purchase technique.
Open Maket
In the United States, dividends received have historically been taxed as:
Ordinary income
The date the firm mails out its declared dividends is called the:
Payment Date
An alternative way to pay out a firm's earnings to shareholders instead of cash dividends is a:
Stock repurchase
Which of the following investors might prefer a high dividend payout?
Tax-Exempt investors
The Ex-Day Price Drop
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
A stock split increases the number of outstanding shares, while ___.
The total owners' equity remains constant
Dividend policy can best be described as the:
Time pattern of dividend payout
The difference between the lowest and highest prices at which a stock has traded is called its:
Trading Range
Residual Dividend Policy
-Determine capital budget (all the investment the firm will do) -Determine target capital structure (how much of the capital budget will be paid with debt and equity) -Finance investments with a combination of debt and equity in line with the target capital structure ~Remember that retained earnings are equity ~If additional equity is needed, issue new shares -If there are excess earnings, then pay the remainder out in dividends
Which of the following might be tax-exempt investors?
-University endowment funds -Trust funds -Pension funds
A stock's price tends to ___ when dividends are paid.
Decline
When a firm announces to all of its stockholders that it is willing to buy a fixed number of shares at a specific price, it is referred to as a ___.
Tender offer
Which of the following is considered to be the main factor influencing a firm's dividend decision?
The consistency of its dividend policy
The basic question of dividend policy is the choice of ___.
The time pattern of dividend payout
A dividend ___ is calculated as a percentage of the stock's market price.
Yield
Relatively young firms should consider a dividend policy aimed at ___.
Retaining earnings to reinvest in the firm
A dividend can be in the form of cash or ___.
Shares of common stock
A ___ repurchase occurs when a firm repurchases shares from specific individual stockholders.
Targeted
If there are no taxes or flotation costs, then investors will ___.
Be indifferent between dividends and a repurchase
Flotation costs will:
Decrease the value of stock
Dividend Payment
-Declaration Date ~Board declares the dividend and it becomes a liability of the firm -Cume Dividend Day ~Occurs three days before ~Receive dividends if you buy on or before this day -Ex-Dividend Date ~Occurs 2 business days before date of record ~If you buy stock on or after this date, you will not receive the dividend ~Stock price generally drops by about 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
High Payout Desirability
-Desire for current income today instead of waiting ~Individuals in low tax brackets ~Groups that are prohibited from spending principal --> only can spend income (trusts and endowments) -Uncertainty resolution ~No guarantee that the higher future dividends will materialize -Taxes ~Dividend exclusion for corporations ~Tax-exempt investors (not for profit businesses) don't have to worry about differential treatment between dividends and capital gains
Dividend Policy
-Dividends are how corporations/businesses return capital to the stockholders -Dividend policy determines how much the company will pay, when, and in what manner ~Companies can pay cash dividends, stock dividends (give new shares), or repurchase existing shares using cash ~Money that is not returned to the shareholders is reinvested in the company (determines investment potential on future projects)
Does Dividend Policy Matter?
-Dividends matter ~The value of the stock is based on the present value of expected future dividends -Dividend policy itself may not matter ~Dividend policy is the decision to pay dividends today 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
Compromise Dividend Policy
-Goals, ranked in order of importance ~Avoid cutting back on positive NPV projects to pay a dividend ~Avoid dividend cuts ~Avoid the need to sell equity ~Maintain a target debt/equity ratio ~Maintain a target dividend payout ratio -Companies want to accept positive NPV projects, while avoiding negative signals
Stock Dividends
-Pay additional shares of stock instead of cash -Does not impact of the overall firm -Increases the number of outstanding shares -Small stock dividend ~Less than 20 to 25% of the total outstanding shares ~If you own 100 shares and the company declared a 10% stock dividend, you would receive an additional 10 shares ~stock price should go down so the total value of the overall firm stays the same -Large stock dividend ~More than 20 to 25%
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 this 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
A ___ occurs whenever a firm makes a payment to its owners from a source other than current or accumulated retained earnings.
Distribution
When a payment is made from a firm's earnings to its owners in the form of cash, it is called a ___.
Dividend
A strong argument can be made that:
Dividend policy does not matter
The unwillingness of many older, giant firms to cut dividends is referred to as ___.
The legacy effect
What is the likely impact on a stock's price when dividends are paid?
The price will fall
According to the clientele effect, can a firm boost its share price by raising dividends?
Yes, but only if an unsatisfied clientele exists
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 will not be repeated -Liquidating Dividend ~Some or all of the business has been sold
Dividend Policy in Practice
-Residual dividend policy ~firm looks at all of its investment projects first and decides what its going to undertake and then if anything left, will pay out dividends -Constant growth dividend policy ~Dividends increased at a constant rate each year -Constant payout ratio ~Pay a constant percent of earnings each year ~earnings go up = dividends go up ~not commonly used -Compromise dividend policy ~set several objectives, and then go through importance
Clientele Effect
-Some investors prefer low dividend payouts and will buy stock in those companies that offer low dividend payouts -Some investors prefer high dividend payouts and will buy stock in those companies that offer high dividend payouts -Supply and demand between these groups
Which of the following are forms of cash dividends?
-Special dividends -Regular cash dividends -Liquidating Dividends -Extra dividends
Real-World Considerations
-Stock repurchase allows investors to decide if they want the current cash flow and associated tax consequences -Investors face capital gains taxes instead of ordinary income taxes (to delay paying taxes) -In our current tax structure, repurchases may be more desirable due to the options provided stockholders -The IRS recognizes this and will not allow a stock repurchase for the sole purpose of allowing investors to avoid taxes (will fine the firm for the amount)
With a share repurchase, earnings per share will increase, and total earnings will:
Not Change
