?The McGraw-Hill Companies,Inc.,2001
16- 1
Irwin/McGraw-Hill
Chapter 16Fundamentals of Corporate FinanceThird Edition
Dividend
Policy
Brealey Myers Marcus
slides by Matthew Will
?The McGraw-Hill Companies,Inc.,2001
16- 2
Irwin/McGraw-Hill
Topics Covered
?How Dividends are Paid
?How Do Companies Decide on Dividend
Payments
?Why Dividend Policy Should Not Matter
?Why Dividends May Increase Firm Value
?Why Dividends May Reduce Firm Value
?The McGraw-Hill Companies,Inc.,2001
16- 3
Irwin/McGraw-Hill
Dividend Payments
Record Date - Person who owns stock on this
date received the dividend.
Ex-Dividend Date - Date that determines
whether a stockholder is entitled to a dividend
payment; anyone holding stock before this
date is entitled to a dividend.
Cash Dividend - Payment of cash by the firm
to its shareholders.
?The McGraw-Hill Companies,Inc.,2001
16- 4
Irwin/McGraw-Hill
Dividend Payments
Stock Repurchase - Firm buys back stock
from its shareholders.
Stock Dividend - Distribution of additional
shares to a firm’s stockholders.
Stock Splits - Issue of additional shares to
firm’s stockholders.
?The McGraw-Hill Companies,Inc.,2001
16- 5
Irwin/McGraw-Hill
Dividend Payments
Jul 28 Aug 10 Aug 11 Aug 13 Sept 10
Declaration With- Ex-dividend Record Payment
date dividend date date date
date
Share
price
falls
?The McGraw-Hill Companies,Inc.,2001
16- 6
Irwin/McGraw-Hill
Stock Dividend
Example - Amoeba Products has 2 million shares
currently outstanding at a price of $15 per share,
The company declares a 50% stock dividend,How
many shares will be outstanding after the dividend
is paid?
Answer
2 mil x,50 = 1 mil + 2 mil = 3 mil shares
?The McGraw-Hill Companies,Inc.,2001
16- 7
Irwin/McGraw-Hill
Stock Dividend
Example - cont - After the stock dividend what is
the new price per share and what is the new value
of the firm?
Answer
?The value of the firm was 2 mil x $15 per share,or
$30 mil,After the dividend the value will remain
the same.
?Price per share = $30 mil / 3 mil sh = $10 per sh.
?The McGraw-Hill Companies,Inc.,2001
16- 8
Irwin/McGraw-Hill
Stock Repurchase
A sse ts Li abilitie s & E qu ity
A,Or ig ina l ba la nc e sh eet
C a sh $15 0,00 0 De bt 0
Othe r a sse ts 850,000 Equi ty 1,00 0,00 0
Va lue of F irm 1,00 0,00 0 Va lue of F irm 1,00 0,00 0
S ha r e s out sta ndi ng = 100,000
P r ic e pe r sha r e = $1,000,00 0 / 100,000 = $10
Example - Cash dividend versus share repurchase
?The McGraw-Hill Companies,Inc.,2001
16- 9
Irwin/McGraw-Hill
Stock Repurchase
A sse ts Li ab il it ies & E qu it y
B,Afte r ca s h di vi dend
C a sh $5 0,00 0 De bt 0
Oth e r asse ts 85 0,00 0 Eq ui ty 90 0,00 0
Va lu e o f F irm 90 0,00 0 Va lu e o f F irm 90 0,00 0
S har e s o ut stand in g = 10 0,00 0
P r ice p e r shar e = $ 90 0,00 0 / 10 0,00 0 = $9
Example - Cash dividend versus share repurchase
?The McGraw-Hill Companies,Inc.,2001
16- 10
Irwin/McGraw-Hill
Stock Repurchase
A sse ts Li ab il it ies & E qu it y
C,Afte r st o c k r e pu r c h a se
C a sh $5 0,00 0 De bt 0
Oth e r asse ts 85 0,00 0 Eq ui ty 90 0,00 0
Va lu e o f F irm 90 0,00 0 Va lu e o f F irm 90 0,00 0
S har e s o ut stand in g = 90,0 00
P r ice p e r shar e = $ 90 0,00 0 / 90,0 00 = $10
Example - Cash dividend versus share repurchase
?The McGraw-Hill Companies,Inc.,2001
16- 11
Irwin/McGraw-Hill
The Dividend Decision
1,Firms have longer term target dividend payout
ratios.
2,Managers focus more on dividend changes than on
absolute levels.
3,Dividends changes follow shifts in long-run,
sustainable levels of earnings rather than short-run
changes in earnings.
4,Managers are reluctant to make dividend changes
that might have to be reversed,
Lintner’s,Stylized Facts”
(How Dividends are Determined)
?The McGraw-Hill Companies,Inc.,2001
16- 12
Irwin/McGraw-Hill
Dividend Policy is Irrelevant
Example - Assume ABC Co,has no extra cash,but declares a
$1,000 dividend,They also require $1,000 for current
investment needs,Using M&M Theory,and given the following
balance sheet information,show how the value of the firm is not
altered when new shares are issued to pay for the dividend,
Record Date Pmt Date Post Pmt
Cash 1,000 0 1,000 (40sh @ $25)
Asset Value 5,000 5,000 5,000
Total Value 6,000 5,000 6,000
# of Shares 200 200 240
price/share $30 $25 $25
NEW SHARES ARE ISSUED
?The McGraw-Hill Companies,Inc.,2001
16- 13
Irwin/McGraw-Hill
Dividend Policy is Irrelevant
Example - continued - Shareholder Value
Record Pmt Post
Stock 6,000 5,000 6,000
Cash 0 1,000 0
Total Value 6,000 6,000 6,000
Stock = 240sh @ $25 = 6,000
?Assume stockholders purchase the new issue with the cash
dividend proceeds.
?The McGraw-Hill Companies,Inc.,2001
16- 14
Irwin/McGraw-Hill
Dividends Increase Value
Market Imperfections and Clientele Effect
There are natural clients for high-payout stocks,
but it does not follow that any particular firm can
benefit by increasing its dividends,The high
dividend clientele already have plenty of high
dividend stock to choose from.
These clients increase the price of the stock
through their demand for a dividend paying stock,
?The McGraw-Hill Companies,Inc.,2001
16- 15
Irwin/McGraw-Hill
Dividends Increase Value
Dividends as Signals
Dividend increases send good news about cash
flows and earnings,Dividend cuts send bad news.
Because a high dividend payout policy will be
costly to firms that do not have the cash flow to
support it,dividend increases signal a company’s
good fortune and its manager’s confidence in
future cash flows.
?The McGraw-Hill Companies,Inc.,2001
16- 16
Irwin/McGraw-Hill
Dividends Decrease Value
Tax Consequences
Companies can convert dividends into capital
gains by shifting their dividend policies,If
dividends are taxed more heavily than capital
gains,taxpaying investors should welcome such a
move and value the firm more favorably.
In such a tax environment,the total cash flow
retained by the firm and/or held by shareholders
will be higher than if dividends are paid.
?The McGraw-Hill Companies,Inc.,2001
16- 17
Irwin/McGraw-Hill
Dividends Decrease Value
F ir m A F ir m B
Ne x t y e a r s pr ic e $112.50 $102.50
Divide nd $ 0 $10.00
Tota l pr e t a x pa y of f $112.50 $112.50
Toda y s sto c k pr ic e $100 $97.78
Ca pita l g a in $12.50 $4.72
P r e ta x r a t e of r e tur n ( % )
Ta x on div ide nd @ 40% $0,40 x $10 = $4.00
Ta x on c a p ita l g a in @ 20%,20 x $12,50 = $2.50,20 x $4.7 2 = $.94
Tota l a f te r ta x inc o me
( divide nd plus c a pit al
g a ins le ss ta x e s)
(0 + 12.50) - 2.50
= $10.00
( 10.00 + 4.72)
- ( 4.00-,94)
= $9.78
Af te r ta x r a te of r e t ur n ( % )
12.5
100
10
100
= =
= = = =
12 5 15 05
10 10 10 10
14 72
97 78
9 78
97 78
,%, %
,%, %
.
.
.
.
16- 1
Irwin/McGraw-Hill
Chapter 16Fundamentals of Corporate FinanceThird Edition
Dividend
Policy
Brealey Myers Marcus
slides by Matthew Will
?The McGraw-Hill Companies,Inc.,2001
16- 2
Irwin/McGraw-Hill
Topics Covered
?How Dividends are Paid
?How Do Companies Decide on Dividend
Payments
?Why Dividend Policy Should Not Matter
?Why Dividends May Increase Firm Value
?Why Dividends May Reduce Firm Value
?The McGraw-Hill Companies,Inc.,2001
16- 3
Irwin/McGraw-Hill
Dividend Payments
Record Date - Person who owns stock on this
date received the dividend.
Ex-Dividend Date - Date that determines
whether a stockholder is entitled to a dividend
payment; anyone holding stock before this
date is entitled to a dividend.
Cash Dividend - Payment of cash by the firm
to its shareholders.
?The McGraw-Hill Companies,Inc.,2001
16- 4
Irwin/McGraw-Hill
Dividend Payments
Stock Repurchase - Firm buys back stock
from its shareholders.
Stock Dividend - Distribution of additional
shares to a firm’s stockholders.
Stock Splits - Issue of additional shares to
firm’s stockholders.
?The McGraw-Hill Companies,Inc.,2001
16- 5
Irwin/McGraw-Hill
Dividend Payments
Jul 28 Aug 10 Aug 11 Aug 13 Sept 10
Declaration With- Ex-dividend Record Payment
date dividend date date date
date
Share
price
falls
?The McGraw-Hill Companies,Inc.,2001
16- 6
Irwin/McGraw-Hill
Stock Dividend
Example - Amoeba Products has 2 million shares
currently outstanding at a price of $15 per share,
The company declares a 50% stock dividend,How
many shares will be outstanding after the dividend
is paid?
Answer
2 mil x,50 = 1 mil + 2 mil = 3 mil shares
?The McGraw-Hill Companies,Inc.,2001
16- 7
Irwin/McGraw-Hill
Stock Dividend
Example - cont - After the stock dividend what is
the new price per share and what is the new value
of the firm?
Answer
?The value of the firm was 2 mil x $15 per share,or
$30 mil,After the dividend the value will remain
the same.
?Price per share = $30 mil / 3 mil sh = $10 per sh.
?The McGraw-Hill Companies,Inc.,2001
16- 8
Irwin/McGraw-Hill
Stock Repurchase
A sse ts Li abilitie s & E qu ity
A,Or ig ina l ba la nc e sh eet
C a sh $15 0,00 0 De bt 0
Othe r a sse ts 850,000 Equi ty 1,00 0,00 0
Va lue of F irm 1,00 0,00 0 Va lue of F irm 1,00 0,00 0
S ha r e s out sta ndi ng = 100,000
P r ic e pe r sha r e = $1,000,00 0 / 100,000 = $10
Example - Cash dividend versus share repurchase
?The McGraw-Hill Companies,Inc.,2001
16- 9
Irwin/McGraw-Hill
Stock Repurchase
A sse ts Li ab il it ies & E qu it y
B,Afte r ca s h di vi dend
C a sh $5 0,00 0 De bt 0
Oth e r asse ts 85 0,00 0 Eq ui ty 90 0,00 0
Va lu e o f F irm 90 0,00 0 Va lu e o f F irm 90 0,00 0
S har e s o ut stand in g = 10 0,00 0
P r ice p e r shar e = $ 90 0,00 0 / 10 0,00 0 = $9
Example - Cash dividend versus share repurchase
?The McGraw-Hill Companies,Inc.,2001
16- 10
Irwin/McGraw-Hill
Stock Repurchase
A sse ts Li ab il it ies & E qu it y
C,Afte r st o c k r e pu r c h a se
C a sh $5 0,00 0 De bt 0
Oth e r asse ts 85 0,00 0 Eq ui ty 90 0,00 0
Va lu e o f F irm 90 0,00 0 Va lu e o f F irm 90 0,00 0
S har e s o ut stand in g = 90,0 00
P r ice p e r shar e = $ 90 0,00 0 / 90,0 00 = $10
Example - Cash dividend versus share repurchase
?The McGraw-Hill Companies,Inc.,2001
16- 11
Irwin/McGraw-Hill
The Dividend Decision
1,Firms have longer term target dividend payout
ratios.
2,Managers focus more on dividend changes than on
absolute levels.
3,Dividends changes follow shifts in long-run,
sustainable levels of earnings rather than short-run
changes in earnings.
4,Managers are reluctant to make dividend changes
that might have to be reversed,
Lintner’s,Stylized Facts”
(How Dividends are Determined)
?The McGraw-Hill Companies,Inc.,2001
16- 12
Irwin/McGraw-Hill
Dividend Policy is Irrelevant
Example - Assume ABC Co,has no extra cash,but declares a
$1,000 dividend,They also require $1,000 for current
investment needs,Using M&M Theory,and given the following
balance sheet information,show how the value of the firm is not
altered when new shares are issued to pay for the dividend,
Record Date Pmt Date Post Pmt
Cash 1,000 0 1,000 (40sh @ $25)
Asset Value 5,000 5,000 5,000
Total Value 6,000 5,000 6,000
# of Shares 200 200 240
price/share $30 $25 $25
NEW SHARES ARE ISSUED
?The McGraw-Hill Companies,Inc.,2001
16- 13
Irwin/McGraw-Hill
Dividend Policy is Irrelevant
Example - continued - Shareholder Value
Record Pmt Post
Stock 6,000 5,000 6,000
Cash 0 1,000 0
Total Value 6,000 6,000 6,000
Stock = 240sh @ $25 = 6,000
?Assume stockholders purchase the new issue with the cash
dividend proceeds.
?The McGraw-Hill Companies,Inc.,2001
16- 14
Irwin/McGraw-Hill
Dividends Increase Value
Market Imperfections and Clientele Effect
There are natural clients for high-payout stocks,
but it does not follow that any particular firm can
benefit by increasing its dividends,The high
dividend clientele already have plenty of high
dividend stock to choose from.
These clients increase the price of the stock
through their demand for a dividend paying stock,
?The McGraw-Hill Companies,Inc.,2001
16- 15
Irwin/McGraw-Hill
Dividends Increase Value
Dividends as Signals
Dividend increases send good news about cash
flows and earnings,Dividend cuts send bad news.
Because a high dividend payout policy will be
costly to firms that do not have the cash flow to
support it,dividend increases signal a company’s
good fortune and its manager’s confidence in
future cash flows.
?The McGraw-Hill Companies,Inc.,2001
16- 16
Irwin/McGraw-Hill
Dividends Decrease Value
Tax Consequences
Companies can convert dividends into capital
gains by shifting their dividend policies,If
dividends are taxed more heavily than capital
gains,taxpaying investors should welcome such a
move and value the firm more favorably.
In such a tax environment,the total cash flow
retained by the firm and/or held by shareholders
will be higher than if dividends are paid.
?The McGraw-Hill Companies,Inc.,2001
16- 17
Irwin/McGraw-Hill
Dividends Decrease Value
F ir m A F ir m B
Ne x t y e a r s pr ic e $112.50 $102.50
Divide nd $ 0 $10.00
Tota l pr e t a x pa y of f $112.50 $112.50
Toda y s sto c k pr ic e $100 $97.78
Ca pita l g a in $12.50 $4.72
P r e ta x r a t e of r e tur n ( % )
Ta x on div ide nd @ 40% $0,40 x $10 = $4.00
Ta x on c a p ita l g a in @ 20%,20 x $12,50 = $2.50,20 x $4.7 2 = $.94
Tota l a f te r ta x inc o me
( divide nd plus c a pit al
g a ins le ss ta x e s)
(0 + 12.50) - 2.50
= $10.00
( 10.00 + 4.72)
- ( 4.00-,94)
= $9.78
Af te r ta x r a te of r e t ur n ( % )
12.5
100
10
100
= =
= = = =
12 5 15 05
10 10 10 10
14 72
97 78
9 78
97 78
,%, %
,%, %
.
.
.
.
