dividend policy - unideb.huoktato.econ.unideb.hu/domician/downloads/ppt/c16b_new.pdf · slide...

Copyright © 2011 Pearson Prentice Hall. All rights reserved.

Dividend Policy

Chapter 16

Copyright © 2011 Pearson Prentice Hall. All rights reserved.16-2

Slide Contents

• Learning Objectives

• Principles Used in This Chapter

1.How Do Firms Distribute Cash to their Shareholders?

2.Does Dividend Policy Matter?

3.Cash Distribution Policies in Practice

• Key Terms


Learning Objectives

1. Distinguish between the use of cash dividends and share repurchases.

2. Understand the tax treatments of dividends and capital gains, and stock dividends and stock splits.

3. Describe corporate dividend policies that are commonly used in practice.


Principles Used in This Chapter

• Principle 1: Money Has a Time Value.

• Principle 3: Cash Flows Are the Source of Value.

• Principle 4: Market Prices Reflect Information.


How Do Firms Distribute Cash to their Shareholders?

Cash distributions can take two basic forms:

• With cash dividend, cash is paid directly to the shareholders.

• With a share repurchase, a company uses cash to buy back its own shares from the market place, thereby reducing the number of outstanding shares.


Remember: The Balane Sheet

Current AssetsCashAccounts ReceivableInventoriesOther current assetsTotal current assets

Current LiabilitiesAccounts payableShort-term debtOther current liabilities

Total current liabilities

Long-term LiabilitiesLong-term debt

Long-term (fixed) assetsGross PPELess: Accumulated depreciationNet property, plant and equip.

Other long-term assets

Total long-term assets

Owner’s EquityPar value of common stockPaid-in-capitalRetained earningsTotal equity

Total Assets Total Liabilities and Owners’ equity


How Do Firms Distribute Cash to their Shareholders? (cont.)

• The impact on the balance sheet will be as follows:

– On the Assets side, cash will be reduced due to cash dividend or share repurchase.

– On the Equity side, there will be a corresponding decrease.


16.2 Does Dividend Policy Matter?


Does Dividend Policy Matter?

• Modigiliani and Miller suggest that without taxes and transaction costs, cash dividends and share repurchases are equivalent and the timing of the distribution is unimportant.

• This is known as the Modigiliani and Miller dividend irrelevancy proposition.


The Irrelevance of the Distribution Choice

• The distribution choice is irrelevant under the following assumptions:

1. There are no taxes.

2. No transaction costs are incurred in either buying or selling shares of stock.

3. The firm’s operating and investment policies are fixed.


Individual Investor Wealth Effects –Personal Taxes

• What are the tax rules with regard to dividends and share repurchases?

1.100% of cash dividends are taxable in the year in which they are received.

2.When individuals sell shares, tax is assessed only on the capital gain (i.e. price appreciation of stock).

3. If an individual decides not to sell his or her share back to the company making the stock repurchase, they will not incur any taxes.


Why Dividend Policy is Important?

• Transactions are costly

–Since taxes are incurred when dividends are received and transactions costs are incurred when buying and selling shares, investors will prefer to select companies whose dividend policy match up with their own preferences.

Because firms with different dividends attract different dividend clienteles(clients), it is important that dividend policy remain somewhat stable.


Why Dividend Policy is Important? (cont.)

• A second possibility is that stock splits and stock dividends tend to attract attention. Naturally, firm would like to attract attention only when the prospects are favorable.

• Thus even though there is no direct effect on cash flows, the market reacts favorably.


Cash Distribution Policies in Practice

• Stable Payout

–In a survey of CEO (Chief Executive Officers)s, most CEOs recognized the importance of maintaining consistency and stability in dividend policy.

–See figure 16-3, panel a and b.


16.3 Cash Distribution Policies in Practice


Figure 16.3 (Cont.)


Stock Repurchase Decisions

• Figure 16-4 reveals (shed light on) that stock repurchase decisions are driven by executive’s feeling that the stock is a good investment relative to its true value

• and that there are a lack of good investment opportunities to invest in.


Dividends versus Repurchases

• Table 16-3 provides a summary of factors influencing the payout policy.

• Flexibility emerges as a major factor in the choice of repurchases as opposed to dividends.


•The end….

dividend policy - unideb.huoktato.econ.unideb.hu/domician/downloads/ppt/c16b_new.pdf · slide...

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