Dividends and Dividend Policy - Chapter 14

Angelo owns 522 shares of a stock with a current market value of $59 per share. What will this investment be worth to Angelo if the firm does a 4-for-3 stock split?

$30,798

Oxnard Associates has stock outstanding that pays a $1.60 annual dividend and sells for $35.00 a share. What will the stock price be when the price is adjusted for the dividend if the applicable tax rate on dividends is 20 percent?

$33.72

information content of dividends & repurchases

* changes in the dividend signal management's view concerning the firm's future prospects * stock repurchases signal that managment believes the current stock price is low * tender offers send a more positive signal than open market repurchases because the company is stating a specific stock price * stock prices often increase when repurchases are announced

stock dividends

- Distributes additional shares of stock instead of cash. - Increases the number of outstanding shares - small stock dividend (less than 20 to 25%) - large stock dividend (more than 20 to 25%)

A stock dividend will result in which of the following?

- a decrease in the value per share - an increase in shares outstanding

Which of the following involves a firm distributing stock instead of cash to its owners?

- a stock dividend - a stock split

A reverse stock split results in

- an investor owning less shares - a higher share price

tax effects of stock repurchases

- cash dividends: no investor control over timing or size and taxed as ordinary income. - repurchase: allows investors to decide if they want a current cash flow. Taxed only if they choose to sell and they reap a capital gain on the sale. Gain may qualify as lower taxed capital gains if shares owned more than one year.

Which of the following are true relative to dividends?

- dividend increases tend to lag earnings increases - dividend stability is important - investors will view a dividend cut as bad news

Dividends received by shareholders can be expressed in which of the following ways?

- dividend payout - dividends per share - dividend yield

stock splits

- essententially the same as a stock dividend except expressed as a ratio, for example, a 2-for-1 stock split is the same as a 100% stock dividend. - stock price is reduced when the stock splits - common explanation for split is to return price to a more desirable trading range

Which of the following are forms of cash dividends?

- extra dividends - liquidating dividends - regular cash dividends - special dividends

Which of the following are factors which favor a low dividend payout?

- flotation costs - bond covenant restrictions - tax laws

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.

repurchase vs cash dividend

- repurchase returns cash from the firm to the stockholders - same as cash dividend in the absence of taxes and trasaction costs

reverse stock splits

- reverse split reduces number of shares outstanding, for example, a 1-for-5 stock split replaces every 5 shares of stock with one share. - Reasons: 1. transactions costs may be less for investors 2. liquidity might be improved 3. too low a price not considered respectable 4. exchange minimum price per share requirements

A firm can pay out its cash earnings to its shareholders in which of the following ways?

- share repurchase - dividends

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

Which of the following are reasons why investors might favor a high dividend payout?

- transaction costs for selling low dividend stocks can be avoided - a preference for current income - stock sales are time consuming

Which of the following might be tax-exempt investors?

- university endowment funds - trust funds - pension funds

dividend summary

1. aggregate dividend and stock repurchases are massive and have increased steadily. 2. dividends heavily concentrated among a small number of large firms 3. managers very reluctant to cut dividends 4. managers smooth dividends, raising them slowly as earning grow 5. stock prices react to unanticipated changes in dividends

factors that affect dividend decisions

1. avoid reducing dividends per share 2. maintain a smooth dividend from year to year 3. consider the level of dividends per share paid in recent quarters 4. reluctance to make dividend changes that might have to be reversed in the future

pros of paying dividends

1. cash dividends underscorce good results and provide support to stock price 2. dividends may attract institutional investors 3. stock price usually increases with a new or increased dividend 4. dividends absorb excess cash and may reduce agency costs

Factors favoring a high payout

1. desire for current income: individuals in low tax brackets and groups that are prohibited from spending principal (trusts and endowments) 2. uncertainty resolution: no guarantee that the higher future dividends will materialize 3. taxes: dividend exclusion for corporations and dividends versus capital gains irrelevant to tax-exempt investors

cons of paying dividends

1. dividends are taxed to recipients 2. dividends can reduce internal sources of funding - may force firm to forgo positive NPV projects or may require external financing 3. once established, dividend cuts are hard to make withough adversely affecting a firm's stock price.

factors favoring a low dividend payout

1. taxes: individuals in upper income tax brackets might prefer lower dividend payouts, with their immediate tax consequences, in favor of higher capital gains 2. flotation costs: low payouts can decrease the amount of capital that needs to be raised, thereby lowering flotation costs 3. dividend restrictions: debt covenants may limit the percentage of income that can be paid out as dividends

In 2010, 80% of the aggregate dividends from US companies were paid by:

100 large firms

Janice owns 390 shares of Abbot stock. How many shares will she own if the firm declares a 2-for-5 reverse stock split?

156 shares

You own 100 shares of ABC company which is trading at $10 a share. The firm announces a 2-for-1 stock split, after which you will have ___ shares which will trade at approximately ____ per share.

200; $5.00

stock repurchase

Company buys back shares of its own stock. - open market = company buys its own stock in the open market - tender offer = company states a purchase price and a desired number of shares to be bought - targeted repurchase = firm repurchases shares from specific individual shareholders

Does dividend policy matter?

Dividend policy may not matter. 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. What matters is the dividends (cash). The value of the stock is based on the present value of expected future dividends.

Which one of the following is a con to paying dividends?

Dividends are hard to cut without affecting the stock price.

Which one of the following statements is correct?

Dividends are heavily concentrated among a small number of firms.

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.

clientele effects

Investors will buy stock in companies that meet their dividend preferences. Some investors prefer low dividend payouts and some prefer high payouts.

Which one of the following statements is correct?

Pension fund shareholders tend to prefer high dividend payouts.

What is the likely impact on a stock's price when dividends are paid?

The price will fall.

ex-dividend day price drop

The stock price will fall by the amount of the dividend on the ex date (time 0).

In the US, dividends have historically been taxed at ____ rate compared with capital gains.

a higher

The dividend policy question addresses whether the firm should payout:

a larger or smaller percentage of its earnings now

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.

When a firm authorizes a trustee to repurchase shares as they become availabe, they are using _____ purchase technique.

an open market

If there are no taxes or flotation costs, then investors will

be indifferent between dividends and a repurchase

declaration date

board declares the dividend and it becomes a liability of the firm

regular cash dividend

cash payments made directly to stockholders, usually each quarter

date of payment

checks are mailed

Because Norman Structures stock has a high dividend payout ratio and a constantly increasing dividend payment, the firm tends to attract only those investors who prefer high-dividend paying stocks. Which one of the following terms is used to describe this relationship between a firm's dividend policy and the firm's shareholders?

clientele effect

A firm's ability to pay dividends may be restricted by:

covenants in a bond indenture

A cash dividend becomes a liability of the issuing firm on the _____ date and affects the stock price on the ____ date.

declaration; ex-dividend

A strong argument can be made that:

dividend policy does not matter

Which one of the following will increase when a firm repurchases shares of outstanding stock?

earnings per share

To a tax-paying stockholder, a stock repurchase

has significant tax advantages compared to a cash dividend

date of record

holders of record are determined, and they will receive the dividend payment.

extra cash dividend

indication that the "extra" amount may not be repeated in the future

A firm which pays cash dividends is signaling ...

it expects to continue to be profitable it is not hording too much cash

According to a recent survey, the highest priority for financial managers is to

maintain a consistent dividend policy

With a share repurchase, earnings per share will increase, and total earning will:

not change.

In the US, dividends received have historically been taxed as...

ordinary income

The date the firm mails out its declared diviends is called the

payment date

A firm is debating between a stock repurchase and a cash dividend. In a world without imperfections, which one of the following will be the same whether the firm chooses the stock repurchase or the cash dividend?

price-earnings ratio

Relatively young firms should consider a dividend policy aimed at ..

retaining earning to reinvest in the firm.

A dividend can be in the form of cash or ...

shares of common stock

special cash dividend

similar to extra dividend, but definitely won't be repeated

liquidating dividend

some or all of the business has been sold

A ____ repurchase occurs when a firm repurchases shares from specific individual stockholders.

targeted

Which of the following investors might prefer a high dividend payout?

tax-exempt investors

The concept that stocks attract certain investors due to a firm's dividend policy and the resulting tax impact is called ____.

the clientele effect

The unwillingness of many, older, giant firms to cut dividends is referred to as ____.

the legacy effect

The difference between the lowest and highest prices at which a stock has traded is called its

trading range

A dividend ____ is calculated as a percentage of the stock's market price,

yield