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Questions and Answers
Which factor primarily determines whether a stockholder is entitled to receive a specific dividend payment?
Which factor primarily determines whether a stockholder is entitled to receive a specific dividend payment?
- Ex-dividend Date (correct)
- Payment Date
- Declaration Date
- Record Date
Which of the following best describes what happens in a two-for-one stock split?
Which of the following best describes what happens in a two-for-one stock split?
- Each investor receives one additional share for each share they already hold. (correct)
- Investors must pay twice the amount for each share they already hold.
- Each investor receives two additional shares for each share they already hold.
- Each investor receives one additional share for every two shares they hold.
ABC Corporation has its stock selling for $40 per share when a 5% stock dividend is declared. Peter owns 200 shares of ABC Corporation. How many additional shares will Peter receive?
ABC Corporation has its stock selling for $40 per share when a 5% stock dividend is declared. Peter owns 200 shares of ABC Corporation. How many additional shares will Peter receive?
- 20 shares
- 5 shares
- 15 shares
- 10 shares (correct)
Amoeba Products has 4 million shares outstanding at a price of $20 per share. The company declares a 25% stock dividend. How many shares will be outstanding after the dividend is paid?
Amoeba Products has 4 million shares outstanding at a price of $20 per share. The company declares a 25% stock dividend. How many shares will be outstanding after the dividend is paid?
Following a stock dividend, what typically happens to the firm's total value and the price per share?
Following a stock dividend, what typically happens to the firm's total value and the price per share?
What signal does an increase in dividend payments typically convey to the market regarding a company's financial health?
What signal does an increase in dividend payments typically convey to the market regarding a company's financial health?
Which of the following is NOT a typical method for a company to repurchase its own stock?
Which of the following is NOT a typical method for a company to repurchase its own stock?
Which of the following statements reflects a common sentiment among senior executives regarding dividend policy?
Which of the following statements reflects a common sentiment among senior executives regarding dividend policy?
Under what condition, according to the dividend irrelevance theory, will dividend policy have no impact on the value of the firm?
Under what condition, according to the dividend irrelevance theory, will dividend policy have no impact on the value of the firm?
Rational Demiconductor has no extra cash but declares a $2,000 dividend and requires $2,000 for current investment needs. According to M&M theory, what action would keep the value of the firm unaltered?
Rational Demiconductor has no extra cash but declares a $2,000 dividend and requires $2,000 for current investment needs. According to M&M theory, what action would keep the value of the firm unaltered?
In a market with natural clienteles, how do high-payout stocks affect different groups of investors?
In a market with natural clienteles, how do high-payout stocks affect different groups of investors?
What is a primary disadvantage of high dividend payouts related to taxation?
What is a primary disadvantage of high dividend payouts related to taxation?
How does payout policy typically evolve as a firm progresses from a young growth stage to maturity?
How does payout policy typically evolve as a firm progresses from a young growth stage to maturity?
What is the primary goal of stock repurchase?
What is the primary goal of stock repurchase?
What is the correct order of dates related to dividend payments?
What is the correct order of dates related to dividend payments?
What is the effect of stock dividend on shareholder's equity?
What is the effect of stock dividend on shareholder's equity?
How can dividend cuts affect investors' confidence?
How can dividend cuts affect investors' confidence?
What is Greenmail in stock repurchase methods?
What is Greenmail in stock repurchase methods?
If a shareholder doesn't participate in share purchase, what will happen to their total wealth?
If a shareholder doesn't participate in share purchase, what will happen to their total wealth?
In which conditions would dividend policy be considered irrelevant?
In which conditions would dividend policy be considered irrelevant?
What is one way companies convert dividends into capital gains?
What is one way companies convert dividends into capital gains?
How do investors react once the firm matures?
How do investors react once the firm matures?
Which corporate action directly decreases cash and shareholder's equity?
Which corporate action directly decreases cash and shareholder's equity?
Which of the following is true when dividends and capital gains are taxed differently?
Which of the following is true when dividends and capital gains are taxed differently?
Which of the following is typically true regarding investor attitudes during a young growth firm's lifecycle?
Which of the following is typically true regarding investor attitudes during a young growth firm's lifecycle?
When do companies usually decide to undertake open-market repurchase?
When do companies usually decide to undertake open-market repurchase?
A company has $5 million in cash, $15 million in asset value, and 1 million shares outstanding. What is the stock price after declaring $1 per share in cash dividend.
A company has $5 million in cash, $15 million in asset value, and 1 million shares outstanding. What is the stock price after declaring $1 per share in cash dividend.
Which of the following is true based on the dividend decision survey?
Which of the following is true based on the dividend decision survey?
A firm is implementing measures to minimize shareholders' immediate tax bill. Which dividend policy is most aligned with this objective?
A firm is implementing measures to minimize shareholders' immediate tax bill. Which dividend policy is most aligned with this objective?
What conditions must be true to make dividend policy irrelevant?
What conditions must be true to make dividend policy irrelevant?
How does a stock split impact a company's financials? Assume the par value is reduced proportionately.
How does a stock split impact a company's financials? Assume the par value is reduced proportionately.
What is the impact on a company's balance sheet from a stock buyback?
What is the impact on a company's balance sheet from a stock buyback?
Which action may signal good fortune, increase value, and boost manager's confidence?
Which action may signal good fortune, increase value, and boost manager's confidence?
Flashcards
Cash Dividend
Cash Dividend
Payment of cash by the firm to its shareholders.
Ex-Dividend Date
Ex-Dividend Date
Date determining stockholder eligibility for a dividend payment.
Record Date
Record Date
Those who own stock on this date receive the dividend.
Stock Dividend
Stock Dividend
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Stock Splits
Stock Splits
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Stock Repurchase
Stock Repurchase
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Tender offer
Tender offer
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Auction (Dutch auction)
Auction (Dutch auction)
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Direct negotiation (Greenmail)
Direct negotiation (Greenmail)
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Dividend Changes
Dividend Changes
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Market imperfection
Market imperfection
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Agency cost of idle cash
Agency cost of idle cash
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Dividends as Signals
Dividends as Signals
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Tax Consequences
Tax Consequences
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Young growth firms
Young growth firms
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Study Notes
Payout Policy
- Payout policy dictates how a corporation distributes cash to its shareholders
- Key objectives include understanding methods of cash distribution, the informational impact of dividends and repurchases, comparing dividends and repurchases, and factors influencing the increase or decrease of value
Facts About Payout
- The payout practices of nonfinancial firms were analyzed from 2011-2020
- 24.1% firms both paid dividends and repurchased stock
- 23.7% of firms repurchased stocks but did not pay dividend
- 12.0% paid dividend but did not repurchase stock
- 40.1% neither paid dividends or repurchased stock
Dividend and Stock Repurchases
- Analysis looks at dividends and stock repurchases by nonfinancial companies in the U.S
- Data spans from 1985-2020
- Repurchases and dividends have both grown over the time, with repurchases being higher in value
Dividend Payments
- Dividend payment process involves several key dates: declaration, ex-dividend, record, and payment
- Declaration Date: The firm communicates its intention to distribute a dividend
- Ex-Dividend Date: Stock trades without the dividend
- Record Date: Determines shareholders eligible for the dividend
- Payment Date: Dividend checks are mailed to shareholders
Types of Dividend Payments
- Cash Dividend: The firm pays cash to its shareholders
- Stock Dividend: Shareholders receive additional company stock
- Stock Splits: Additional shares issued to firm's stockholders
- Stock Repurchase: Firm redistributes cash to stockholders by buying back shares, which is also known as stock buyback
Stock Dividend and Stock Split
- Issuing more shares does not alter the overall assets, earnings, or value of the firm
- Stock dividend equivalents can be calculated
- The key difference is the share price decreases
Stock Dividend Example
- Amoeba Products with 2 million outstanding shares at $15/share declared a 50% stock dividend
- Outstanding shares after dividend: 2 million * 0.50 = 3 million shares
- With total value unchanged at $30 million (2 million shares * $15), the price per share after dividend becomes $10 ($30 million / 3 million shares)
Payout Information
- Increase in dividends often signals managers' positive expectations about future cash flow and earnings
- Cutting dividends signals a lack of confidence, often interpreted as negative information
Stock Repurchase Methods
- Open-market repurchase: The most common method
- Tender offer: A company offers to buy shares at a fixed price, allowing shareholders to sell if they choose
- Auction (Dutch auction): Shareholders bid within a price range
- Direct negotiation (Greenmail): Company buys shares from a specific investor, often at a premium, to prevent a hostile takeover
Dividend Decision Survey (2005)
- Firms try to avoid reducing dividends (93.8%), maintain a smooth dividend stream (89.6%), and consider current dividend levels (88.2%)
- Most are reluctant to alter dividends (77.9%) and consider the dividend change (66.7%)
- When choosing between cutting dividends or raising new funds for a beneficial project, most favored raising new funds (65.4%)
- Few agreed that the cost of external capital is lower than that of a dividend cut (42.8%)
Case study in Cash Dividend versus Share Repurchase
- An original balance sheet shows a theoretical firm with $150,000 cash, $950,000 other assets, and $1,100,000 equity, with 100,000 shares outstanding
- A cash dividend decreases shareholder equity
- A stock repurchase does not decrease shareholder equity
Dividend Irrelevance
- In a scenario without dividends, a shareholder's wealth remains at $11 per share
- With a cash dividend, the share price drops, but is compensated by the dividend
- With a share repurchase, the investor either holds unchanged shares or sells to hold an equivalent cash value
Dividend Decision Insights
- Managers avoid changing dividends and tend to "smooth" dividend payments
- Shifts in long-term earnings drive dividend adjustments
- Dividend decisions driven by target payout ratios, repurchase decisions, and information content
Irrelevance of Dividend Policy
- Investors can convert shares to cash without dividends, so higher dividend payouts do not indicate higher prices
- Dividend policy has no impact if capital markets are efficient and investment/operating policies are unchanged
Example of Irrelevance of dividend policy
- Rational Demicondutor has no extra cash but declares a $1,000 dividend and requires $1,000.
- M&M Theory states that that issuing new shares will alter firm value if they had a value of $1,000 cash, $9,000 asset value, with 1,000 issued shares at $12 per share.
- Post Payment Date: New shares get issued (91) shares at $11, cash returned at $1000
- The value remained unaffected even upon dividend payments
Dividends Impact in Imperfect Markets
- High-payout stocks attract a specific clientele; their prices may surge due to demand for dividend stocks
- Corporate managers with plenty of cash but few valuable investment opportunities face a potential agency cost
- Investors favor higher cash payouts to force a disciplined investment
Dividends as Signals
- Dividend increases signal positive news, while dividend cuts signal negative news
- Regular dividend boosts signal a company's solid cash flow and the confidence of its managers
Dividends Decrease Value: Role of Taxation
- If the dividend tax rate is higher compared to capital gains, selling the high payout stock must sell at a lower price to provide the same after-tax return
- In such scenario, investors could find the firm's dividend policies unappealing and lower the firm value
Tax Consequences
- Companies can use tax schemes if the dividend policies become an issue, like capital gains
- Investors will have to welcome such a move to value the firm for more favorable outcome
- Retained cash flows will be higher in a taxed environment than the declared dividend payments
Dividend Over a Business Lifecycle
- Payout is a by-product of financial decision, given investment and financing decisions
- Young firms often have lower payouts due to investment opportunities and retaining cash
- Investors are not cautious about overinvestment due to managers compensation being tied to the stock price
- Mature firms often offer increased payout; positive NPV project becomes scares; Investors worry about free cash flow
- Aging firms often have higher payouts being called for
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