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Forward Contracts On A Security That Provides A Known Dividend Yield

As will be explained in later sections, both currencies and stock indices can be regarded as securities that provide known dividend yields. In this section, we provide a general analysis of forward contracts on such securities. A known dividend yield means that the income when expressed as a percentage of the security price is known. We will assume that the dividend yield is paid continuously at an annual rate q. To illustrate what this means, suppose that q 0.05 so that the dividend yield is 5 percent per annum. When the security price is 10, dividends in the next small interval of time are paid at the rate of 50 cents per annum when the security price is 100, dividends in the next small interval of time are paid at the rate of 5 per annum and so on. Note that if the dividend yield rate varies during the life of the forward contract, Equation (3.10) is still correct with q equal to the average dividend yield rate. Consider a 6-month forward contract on a security that is expected to...

The Constantgrowth Dividend Discount Model

The dividend discount model requires a forecast of dividends for every year into the future, which poses a bit of a problem for stocks with potentially infinite lives. Unless we want to spend a lifetime forecasting dividends, we must use simplifying assumptions to reduce the number of estimates. The simplest simplification assumes a no-growth perpetuity which works for no-growth common shares. Here's another simplification that finds a good deal of practical use. Suppose forecast dividends grow at a constant rate into the indefinite future. If dividends grow at a steady rate, then instead of forecasting an infinite number of dividends, we need to forecast only the next dividend and the dividend growth rate. Plug these forecasts of future dividends into the dividend discount model CONSTANT-GROWTH DIVIDEND DISCOUNT MODEL Version of the dividend discount model in which dividends grow at a constant rate. Although there is an infinite number of terms, each term is proportionately smaller...

Using Analyst Forecasts to Estimate the Expected Dividend Growth Rate To

Compute the risk-adjusted discount rate for equity from this equation, only g, the expected rate of growth of the firm's dividends, and div 1 So, the firm's dividend yield, 13A historical average of the ratio of dividend per share to prior year stock price per share, sometimes over a period of five years, can be used if the coming year's dividend payout is expected to be unusual. provide one estimate for g. Under the assumption that a firm pays a fixed percentage of its earnings as dividends, the expected growth rate in dividends equals the forecasted growth rate in earnings. This growth rate can then be added to the existing dividend yield to derive the expected return on the firm's stock.14 For example, suppose that Value Line, an investment advisory service, forecasts a 12.9 percent rate of growth for IBM's earnings. Adding this to the firm's 0.5 percent dividend yield (as of early 2001) implies an expected rate of return on IBM stock of 13.4 percent. To obtain a cost of capital...

Real World Factors Favoring a High Dividend Policy

In a previous section, we pointed out that dividends are taxed at the personal level. This implies that financial managers will seek out ways to reduce dividends, though a complete elimination of dividends would be unlikely for firms with strong cash flow. We also pointed out that share repurchase is a way financial managers can convey many of the same benefits of a dividend without the tax disadvantage. In this section, we consider reasons why a firm might pay its shareholders high dividends, even in the presence of high personal taxes on dividends. Miller and Modigliani point out that this argument is not relevant to their theoretical model. An individual preferring high current cash flow but holding low-dividend securities could easily sell off shares to provide the necessary funds. Thus, in a world of no transactions costs, a high-current-dividend policy would be of no value to the stockholder. However, the current income argument does have relevance in the real world. Here the...

Capital Structure and Dividend Policy

18 Dividend Policy Why Does It Matter 495 Corporate Finance, Sixth Dividend Policy Part IV Capital Structure and Dividend Policy We discuss dividend policy in Chapter 18. It seems surprising that much empirical evidence and logic suggest that dividend policy does not matter. There are some good reasons for firms to pay low levels of dividends lower taxes and costs of issuing new equity. However, there are also some good reasons to pay high levels of dividends to reduce agency costs and to satisfy low-tax, high-income clienteles. Corporate Finance, Sixth Dividend Policy An Introduction Companies, 2002

How can one calculate the present value of a stock given forecasts of future dividends and future stock price

Stockholders generally expect to receive (1) cash dividends and (2) capital gains or losses. The rate of return that they expect over the next year is defined as the expected dividend per share DIV1 plus the expected increase in price P1 - P0, all divided by the price at the start of the year P0. Unlike the fixed interest payments that the firm promises to bondholders, the dividends that are paid to stockholders depend on the fortunes of the firm. That's why a company's common stock is riskier than its debt. The return that investors expect on any one stock is also the return that they demand on all stocks subject to the same degree of risk. The present value of a stock equals the present value of the forecast future dividends and future stock price, using that expected return as the discount rate.

A1 The Gordon model with two dividend growth rates

The assumption of a single future growth rate may, however, be problematic. Just as for the FCF examples in section 16.2 we concluded that there might be 2 FCF growth rates, it is often plausible to assume that there are 2 dividend growth rates. Typically, we assume that an initial period of high dividend growth is followed by normal dividend growth. In the equation below we've assume that dividends grow at a high growth rate for 5 years and that afterwards the growth rate slows down to a normal dividend growth rate. In this case the basic Gordon model equation becomes The present value of the first five years of dividend growth, assumed to grow at a high growth rate, ghigh

How Might The Expected Future Reappearance Of Higher Tax Rates On Individuals Receiving Dividends Affect Corporate

Expected cash dividends are the key return variable from which owners and investors determine share value. They represent a source of cash flow to stockholders and provide information about the firm's current and future performance. Because retained earnings, earnings not distributed to owners as dividends, are a form of internal financing, the dividend decision can significantly affect the firm's external financing requirements. In other words, if the firm needs financing, the larger the cash dividend paid, the greater the amount of financing it must raise externally through borrowing or through the sale of common or preferred stock. (Remember that although dividends are charged to retained earnings, they are actually paid out of cash.) The first thing to know about cash dividends is the procedures for paying them. At quarterly or semiannual meetings, a firm's board of directors decides whether and in what amount to pay cash dividends to corporate stockholders. The past period's...

Subsidiary Stock Dividends

A subsidiary may issue stock dividends to convert retained earnings into paid-in capital. The minimum amount to be removed from retained earnings is the par value or stated value of the shares distributed. However, according to accounting principles, when the distribution does not exceed 20 to 25 of the previously outstanding shares, an amount equal to the fair value of the shares should be removed from retained earnings and transferred to paid-in capital. The recording of stock dividends at fair value is defended by the following statement from ARB No. 43 . . . a stock dividend does not, in fact, give rise to any change whatsoever in either the corporation 's assets or its respective shareholders 'proportionate interests therein. However, it cannot fail to be recognized that, merely as a consequence of the expressed purpose of the transaction and its characterization as a dividend in related notices to shareholders and the public at large, many recipients of stock dividends look upon...

Cash Dividends And Dividend Payment

The term dividend usually refers to cash paid out of earnings. If a payment is made from sources other than current or accumulated retained earnings, the term distribution, rather than dividend, is used. However, it is acceptable to refer to a distribution from earnings as a dividend and a distribution from capital as a liquidating dividend. More generally, any direct payment by the corporation to the shareholders may be considered a dividend or a part of dividend policy. Dividends come in several different forms. The basic types of cash dividends are 1. Regular cash dividends Later in the chapter, we discuss dividends paid in stock instead of cash, and we also consider another alternative to cash dividends, stock repurchase.

More on the ExDividend Date

The ex-dividend date is important and is a common source of confusion. We examine what happens to the stock when it goes ex, meaning that the ex-dividend date arrives. To illustrate, suppose we have a stock that sells for 10 per share. The board of directors declares a dividend of 1 per share, and the record date is set to be Tuesday, June 12. Based on our previous discussion, we know that the ex date will be two business (not calendar) days earlier, on Friday, June 8. If you think about it, you will see that the stock is worth about 1 less on Friday morning, so its price will drop by this amount between close of business on Thursday and the Friday opening. In general, we expect that the value of a share of stock will go down by about the dividend amount when the stock goes ex dividend. The key word here is about. Because dividends are taxed, the actual price drop might be closer to some measure of the aftertax value of the dividend. Determining this value is complicated because of...

Does Dividend Policy Matter

To decide whether or not dividend policy matters, we first have to define what we mean by dividend policy. All other things being the same, of course dividends matter. Dividends are paid in cash, and cash is something that everybody likes. The question we will be discussing here is whether the firm should pay out cash now or invest the cash and pay it out later. Dividend policy, therefore, is the time pattern of dividend payout. In particular, should the firm pay out a large percentage of its earnings now or a small (or even zero) percentage This is the dividend policy question.

Dividend Payout Ratio

Formula Divide total annual dividend payments by annual cash flow. If there is a long-standing tradition by the board of directors of continually increasing the amount of the dividend, then annualize the last (and presumably largest) dividend only and use the resulting figure in the numerator of the calculation. The formula is The table reveals that Continental's board of directors is continuing to grant increasing amounts of dividends, despite a steady drop in cash flow. At the current pace of cash flow decline, Continental will be unable to support its current dividend rate in less than two years. Dividend payout ratio

Why Dividend Policy Should Not Matter

The first step toward understanding dividend policy is to recognize that the phrase means different things to different people. Therefore, we must start by defining what we mean by it. A firm's decisions about dividends are often intertwined with other financing and investment decisions. Some firms pay low dividends because management is optimistic about the firm's future and wishes to retain earnings for expansion. In this case the dividend is a by-product of the firm's capital budgeting decision. Another firm might finance capital expenditures largely by borrowing. This frees up cash for dividends. In this case the firm's dividend is a by-product of the borrowing decision. We wish to isolate dividend policy from other problems of financial management. The precise question we should ask is What is the effect of a change in cash dividends paid, given the firm s capital budgeting and borrowing decisions Of course the cash used to finance a dividend increase has to come from somewhere....

Tax and Legal Benefits from High Dividends

Earlier, we saw that dividends were taxed unfavorably for individual investors. This fact is a powerful argument for a low payout. However, there are a number of other investors who do not receive unfavorable tax treatment from holding high-dividend yield, rather than low-dividend yield, securities. Corporate Investors A significant tax break on dividends occurs when a corporation owns stock in another corporation. A corporate stockholder receiving either common or preferred dividends is granted a 70 percent (or more) dividend exclusion. Since the 70 percent exclusion does not apply to capital gains, this group is taxed unfavorably on capital gains. As a result of the dividend exclusion, high-dividend, low-capital gains stocks may be more appropriate for corporations to hold. As we discuss elsewhere, this is why corporations hold a substantial percentage of the outstanding preferred stock in the economy. This tax advantage of dividends also leads some corporations to hold...

Stock Dividends And Stock Splits

Another type of dividend is paid out in shares of stock. This type of dividend is called a stock dividend. A stock dividend is not a true dividend because it is not paid in cash. The effect of a stock dividend is to increase the number of shares that each owner holds. Because there are more shares outstanding, each is simply worth less. A stock dividend is commonly expressed as a percentage for example, a 20 percent stock dividend means that a shareholder receives one new share for every five currently owned (a 20 percent increase). Because every shareholder receives 20 percent more stock, the total number of shares outstanding rises by 20 percent. As we will see in a moment, the result is that each share of stock is worth about 20 percent less. A stock split is essentially the same thing as a stock dividend, except that a split is expressed as a ratio instead of a percentage. When a split is declared, each share is split up to create additional shares. For example, in a three-for-one...

Cash Dividends And Diwidend PayrflEMY

The term dividend usually refers to cash paid out of earnings. If a payment is made from sources other than current or accumulated retained earnings, the term distribution, rather than dividend, is used. However, it is acceptable to refer to a distribution from earnings as a dividend and a distribution from capital as a liquidating dividend. More generally, any direct payment by the corporation to the shareholders may be considered a dividend or a part of dividend policy. Dividends come in several different forms. The basic types of cash dividends are 1. Regular cash dividends Later in the chapter, we discuss dividends paid in stock instead of cash, and we also consider an alternative to cash dividends, stock repurchase.

Some Good Reasons for Paying Dividends

While the tax disadvantages of dividends are clear, especially for individual investors, there are some good reasons why firms that are paying dividends should not suspend them. First, there are investors who like to receive dividends, either because they pay no or very low taxes, or because they need the regular cash flows. Firms that have paid dividends over long periods are likely to have accumulated investors with these characteristics, and cutting or eliminating dividends would not be viewed favorably by this group.

Getting Information on dividend policy

You can get information about dividends paid back over time from the financial statements of the firm. (The statement of changes in cash flows is usually the best source.) To find typical dividend payout ratios and yields for the sector in which this firm operates examine the data set on industry averages on my web site. Online sources of information

Dividend Policy Is Irrelevant in Perfect Capital Markets

Because investors do not need dividends to get their hands on cash, they will not pay higher prices for the shares of firms with high payouts. Therefore firms ought not to worry about dividend policy. They should let dividends fluctuate as a by-product of their investment and financing decisions. 444 PART V Dividend Policy and Capital Structure

Future dividends should influence todays stock price

However, note that while the current stock price reflects information about all future dividends, all dividends are not equally important. Because of discounting, current dividends influence the current stock price more than dividends in the far future. The discounting works as follows. The current stock price depends on the discounted expected price and dividends next period, P(0) P(1) + D(1) (1 + r). We also know that next period's price equals the discounted value of expected prices and dividends in period 2. Therefore, in influencing today's stock price, current dividends are discounted only once, D(1) (1 + r), but dividends expected in period 2 are discounted twice. That is because we have to discount P(1) when considering its influence on P(0) and because P(1) itself depends on discounted dividends in period 2. Therefore, the influence of period 2 dividends on the current stock price is twice discounted, D(2) (1 + r)2. Because (1 + r)2 is greater than (1 + r), future dividends...

Overview of the Dividend Policy Decision

In many ways, our discussion of dividend policy parallels our discussion of capital structure We presented the relevant theories and issues, and we listed some additional factors that influence dividend policy, but we did not come up with any hard-and-fast guidelines that managers can follow. You should recognize that dividend policy decisions are exercises in informed judgment, not decisions that can be based on a precise mathematical model. In practice, dividend policy is not an independent decision the dividend decision is made jointly with capital structure and capital budgeting decisions. The underlying reason for joining these decisions is asymmetric information, which influences managerial actions in two ways The effects of asymmetric information suggest that, to the extent possible, managers should avoid both new common stock sales and dividend cuts, because both actions tend to lower stock prices. Thus, in setting dividend policy, managers should begin by considering the...

Dividend Payouts Use The Annual Financial Statements For General Mills Gis Boston Beer Sam And Us Steel X To Find The

Suppose the only owners of stock are corporations. Recall that corporations get at least a 70 percent exemption from taxation on the dividend income they receive, but they do not get such an exemption on capital gains. If the corporation's income and capital gains tax rates are both 35 percent, what does this model predict the ex-dividend share price will be What does this problem tell you about real-world tax considerations and the dividend policy of the firm Dividend Payouts Use the annual financial statements for General Mills (GIS), Boston Beer (SAM), and US Steel (X) to find the dividend payout ratio for each company for the last three years. Why would these companies pay out a different percentage of income as dividends Is there anything unusual about the dividends paid by US Steel How is this possible 18.1 Dividend Reinvestment Plans As we mentioned in the chapter, dividend reinvestment plans (DRIPs) permit shareholders to automatically reinvest cash dividends in the company....

Stockholder Pressure and Dividend Policy

Which of the following companies would you expect to see under greatest pressure from its stockholders to buy back stock or pay large dividends (All of the companies have costs of capital of 12 .) When a firm pays out more in dividends than it has available in free cash flow to equity, it is creating a cash shortfall. If this firm also has good projects available but cannot invest in them because of capital rationing constraints, the firm is paying a hefty price for its dividend policy. Even if the projects are passed up for other reasons, the cash The best course of action for stockholders is to insist that the firm pay out less in dividends and invest in better projects. If the firm has paid high dividends for an extended period of time and has acquired stockholders who value high dividends even more than they value the firm's long-term health, reducing dividends may be difficult. Even so, stockholders may be much more amenable to cutting dividends and reinvesting in the firm, if...

Dividend Discount Models

When an investor buys stock, he generally expects to get two types of cash flows -dividends during the holding period and an expected price at the end of the holding period. Since this expected price is itself determined by future dividends, the value of a stock is the present value of just expected dividends. The dividend discount model is therefore the most direct and the most conservative way of valuing a stock since it counts only those cashflows that are actually paid out. In it's most general form, the value of a stock in the dividend discount model is the present value of the expected dividends on the stock in perpetuity. Expected Dividends in period t Value of a stock in stable growth Expected Dividends next year (Cost of equity - gj This model is called the Gordon Growth model and is a special case of the dividend discount model. It can be used only for firms that are already in stable growth.3 Breaking down the general version of the dividend discount model, there are four...

MODEL 3 American Options On Stocks With Known Dividend Yields The Problem

Develop a model to estimate the price of American options (both puts and calls) on stocks with known dividend yields using a Cox, Ross, and Rubinstein (CRR) 1 Binomial Pricing of American Options on Stocks with Known Dividend Yield FIGURE 24.3 Model 3 Binomial pricing of American options on stocks with known dividend yield.

Measures of Dividend Policy

Drinking The Table

We generally measure the dividends paid by a firm using one of two measures. The first is the dividend yield, which relates the dividend paid to the price of the stock Dividend Yield Annual Dividends per share Price per share The dividend yield is significant because it provides a measure of that component of the total return that comes from dividends, with the balance coming from price appreciation. Expected Return on Stock Dividend Yield + Price Appreciation Some investors also use the dividend yield as a measure of risk and as an investment screen, i.e., they invest in stocks with high dividend yields. Studies indicate that stocks with high dividend yields earn excess returns, after adjusting for market performance and risk. Figure 10.2 tracks dividend yields on the 2700 listed stocks in the United States that paid Dividend Yield This is the dollar dividend per share divided by the current price per share. dividends on the major exchanges in January 2004. Note, though, that 4800...

Dividends and Dividend Yields

Investors buy stocks for their potential capital gains and or their dividend payments. Companies either share their profits with their shareholders by paying dividends or retain their earnings and reinvest them in different projects in order to boost their share prices. A company's dividend policy is generally made public. For example, some growth companies and other companies choose not to pay dividends, while some of the established blue-chip companies, utility companies, and real estate investment trusts (REITs) are well known for their dividend payments. The dividend amount that listed companies pay can be found in the stock listings in newspapers. Generally, companies try to maintain these stated dividend payments even if they suffer declines in earnings. Similarly, increases in earnings do not always translate into increases in dividends. Certainly there are many examples where companies experience earnings increases that result in increases in dividend payments, but this is not...

Simplifying the Dividend Discount Model

The dividend discount model with no growth Consider a company that pays out all its earnings to its common shareholders. Such a company could not grow because it could not reinvest.6 Stockholders might enjoy a generous immediate dividend, but they could forecast no increase in future dividends. The company's stock would offer a perpetual stream of equal cash payments, DIV1 DIV2 . . . DIVt . . The dividend discount model says that these no-growth shares should sell for the present value of a constant, perpetual stream of dividends. We learned how to do that calculation when we valued perpetuities in Chapter 3. Just divide the annual cash payment by the discount rate. The discount rate is the rate of return demanded by investors in other stocks of the same risk

What We Know and Do Not Know about Dividend Policy

Capital Structure and I 18. Dividend Policy Why I I The McGraw-Hill Corporate Finance, Sixth Dividend Policy Does It Matter Companies, 2002 Chapter 18 Dividend Policy Why Does It Matter 517 TABLE 18.3 Relationship between Dividend Yield and Marginal Tax Rate from Direct Observation of Individual Investors' Portfolios Dividend Yield Stockholders in high marginal tax brackets buy securities with low-dividend yield and vice versa. *Lewellen et al. use several alternative methods to calculate the marginal tax rate from data on income. The results are broadly similar, and above we give the results for their Tax-l definition. Stockholders in high marginal tax brackets buy securities with low-dividend yield and vice versa. *Lewellen et al. use several alternative methods to calculate the marginal tax rate from data on income. The results are broadly similar, and above we give the results for their Tax-l definition. In a recent and fascinating paper, Fama and...

Dividend policy is a tool for changing financing mix

Dividend policy cannot be analyzed in a vacuum. Firms can use dividend policy as a tool to change their debt ratios, In chapter 9, we examined how firms that want to increase or decrease leverage can do so by changing their dividend policy increasing dividends increases leverage over time, and decreasing dividends reduces leverage.

Firms Dividend Policy Tends To Follow The Life Cycle Of The Firm

Life Cycle Dividend

In chapter 7, we introduced the link between a firm's place in the life cycle and its financing mix and choices. In particular, we noted five stages in the growth life cycle -start up, rapid expansion, high growth, mature growth and decline. In this section, we will examine the link between a firm's place in the life cycle and its dividend policy. Not surprisingly, firms generally adopt dividend policies that best fit where they are currently in their life cycles. For instance, high-growth firms with great investment opportunities do not usually pay dividends, whereas stable firms with larger cash flows and fewer projects tend to pay more of their earnings out as dividends. Figure 10.7 looks at the typical path that dividend payout follows over a firm's life cycle. Figure 10.7 Life Cycle Analysis of Dividend Policy Figure 10.7 Life Cycle Analysis of Dividend Policy This intuitive relationship between dividend policy and growth is emphasized when we look at the relationship between a...

Dividend Policy and Investment Incentives

In reality, investors and analysts are usually unable to make accurate inferences about a firm's investment opportunities or how much managers want to invest. As a result, the dividend choice conveys information about both the opportunities and incentives to invest as well as the firm's operating cash flows. This implies that a firm's unanticipated dividend cut could provide a mixed signal. A dividend cut could mean that the firm was less profitable alternatively, the cut could mean that the firm had good opportunities and planned on investing more than investors had previously anticipated. Can Dividend Cuts Signal Improved Investment Opportunities A dividend cut that is interpreted to mean that the firm has increased investment expenditures can be either good news or bad news, depending on whether investors believe that the firm will be investing in positive or negative net present value projects. Woolridge and Ghosh (1985) argued that if firms can effectively communicate to...

The Dividend Discount Model With No Growth

Consider a company that pays out all its earnings to its common shareholders. Such a company could not grow because it could not reinvest.6 Stockholders might enjoy a generous immediate dividend, but they could forecast no increase in future dividends. The company's stock would offer a perpetual stream of equal cash payments, DIV1 DIV2 . . . DIVt . . . The dividend discount model says that these no-growth shares should sell for the present value of a constant, perpetual stream of dividends. We learned how to do that calculation when we valued perpetuities earlier. Just divide the annual cash payment by the discount rate. The discount rate is the rate of return demanded by investors in other stocks of the same risk

Effects of Dividend Policy on rs

The effects of dividend policy on rs may be considered in terms of four factors (1) stockholders' desire for current versus future income, (2) perceived riskiness of dividends versus capital gains, (3) the tax advantage of capital gains over dividends, and (4) the information content of dividends (signaling). Since we discussed each of these factors in detail earlier, we need only note here that the importance of each factor in terms of its effect on rs varies from firm to firm depending on the makeup of its current and possible future stockholders. It should be apparent that dividend policy decisions are truly exercises in informed judgment, not decisions that can be quantified precisely. Even so, to make rational dividend decisions, financial managers must take account of all the points discussed in the preceding sections. Identify the four broad sets of factors that affect dividend policy. What constraints affect dividend policy How do investment opportunities affect dividend...

Establishing A Dividend Policy

How do firms actually determine the level of dividends they will pay at a particular time As we have seen, there are good reasons for firms to pay high dividends, and there are good reasons to pay low dividends. In the next section, we discuss a particular dividend policy strategy. In doing so, we emphasize the real-world features of dividend policy. We also analyze an increasingly important alternative to cash dividends, a stock repurchase.

Summary of Factors Influencing Dividend Policy

In earlier sections, we described both the major theories of investor preference and some issues concerning the effects of dividend policy on the value of a firm. We also discussed the residual dividend model for setting a firm's long-run target payout ratio. In this section, we discuss several other factors that affect the dividend decision. These factors may be grouped into four broad categories (1) constraints on dividend payments, (2) investment opportunities, (3) availability and cost of alternative sources of capital, and (4) effects of dividend policy on rs. Each of these categories has several

Managing Changes in Dividend Policy

In chapter 10, we noted the tendency on the part of investors to buy stocks with dividend policies that meet their specific needs. Thus, investors who want high current cash flows and do not care much about the tax consequences migrate to firms that pay high dividends those who want price appreciation and are concerned about the tax differential hold stock in firms that pay low or no dividends. One consequence of this clientele effect is that changes in dividends, even if entirely justified by the cash flows, may not be well received by stockholders. In particular, a firm with high dividends that cuts its dividends drastically may find itself facing unhappy stockholders. At the other extreme, a firm with a history of not paying dividends that suddenly institutes a large dividend may also find that its stockholders are not pleased. Is there a way in which firms can announce changes in dividend policy that minimizes the negative fall-out that is likely to occur In this section, we will...

Onetime nonrecurring gains due to dividends received or trading gains

CFO technically includes two cash flow items that analysts often re-classify into cash flow from financing (CFF) (1) dividends received from investments and (2) gains losses from trading securities (investments that are bought and sold for short-term profits). If you find that CFO is boosted significantly by one or both of these items, they are worth examination. Perhaps the inflows are sustainable. On the other hand, dividends received are often not due to the company's core operating business and may not be predictable. And gains from trading securities are even less sustainable. They are notoriously volatile and should generally be removed from CFO (unless, of course, they are core to operations, as with an investment firm). Further, trading gains can be manipulated management can easily sell tradable securities for a gain prior to year-end, thus boosting CFO.

The Value of Stock as Related to Dividend Policy

Management determines its dividend policy by evaluating many factors including the tax impact on shareholders the need to generate internal funds to retire debt, invest, or repurchase shares and the desire to maintain a stable dividend level in the face of fluctuating earnings. Since the price of a stock depends primarily on the present discounted value of all expected future dividends, it appears that dividend policy is crucial to determining the value of the stock. But as long as one specific condition holds that the firm earns the same return on its retained earnings as shareholders demand on its stock then future dividend policy does not impact the market value of the firm. This is because dividends not paid today become retained earnings that generate higher dividends in the future, so that the present value of those dividends is unchanged, notwithstanding when they are paid.10 The management can, of course, influence the time path of dividends. The lower the dividend payout...

The Dividend Discount Model

DIVIDEND DISCOUNT MODEL Discounted cashflow model of today's stock price which states that share value equals the present value of all expected future dividends. As it turns out, we can express a stock's value as the present value of all the forecast future dividends paid by the company to its shareholders without referring to the future stock price. This is the dividend discount model How do we get from the one-period formula P0 (DIVj + Pj) (1 + r) to the dividend discount model We look at increasingly long investment horizons.

Multiperiod Dividend Discount Models

When you buy shares, you are essentially buying into the dividend stream. Unless you sell the shares, the only income is the dividend and therefore the value could be viewed as the present value of the future dividends. The simple perpetuity formula is the Gordon's growth model as a shortcut to present valuing a stream of cash flows. The simple formula is g Implied growth Cost ofequity Dividend yield (1+Dividend yield) The simple dividend model assumes a constant rate of growth in perpetuity. It is possible to construct multi-stage models using forecast dividends and different rates of discounting. In the model above, the company forecasts a period of rapid growth over the next five years before dropping back to more modest growth. The dividend rate is 25.0 per cent and the income and dividends are shown on the Data sheet.

Appendix 18A Stock Dividends and Stock Splits

In addition to the cash dividend, companies may issue stock dividends or split their stock. Since stock dividends and stock splits are quite similar, we treat them together. We begin with examples of these two strategies. Next, their benefits and costs to the firm are discussed. Example of a Stock Dividend Imagine a company with 10,000 shares of stock, each selling at 60. With a stock dividend of 10 percent, each stockholder receives one additional share for each 10 that he or she originally owned. Therefore the total number of shares outstanding after the dividend is 11,000. Note that the stockholders receive no cash and that each shareholder's percentage of the total outstanding stock remains the same. Thus a case can be made that a stock dividend is of no value to the firm. More will be said on this later. Imagine that, before the stock dividend, the equity portion of the firm's balance sheet looks like this A seemingly arbitrary accounting procedure is used to adjust the balance...

Dividend yield method

When the dividend is in the form of yield it can be easily 'netted off' from the risk-free interest rate as in the case of a currency option. To calculate the dividend yield of an index option, the dividend yield, q, is the average annualized yield of dividends distributed during the life of the option dividend yield rate computed here is thus from the actual dividends paid during the option's life which will therefore account for the monthly seasonality in dividend payments.

Declaration and Payment of Cash Dividends

Dividends payable Management also specified a date of record, and the dividend was paid to investors who owned the shares on that specific date. Subsequently, the stock was considered ex dividend, which means that subsequent purchasers were not entitled to receive the previously declared dividend. On the date of payment, Du Pont's cash and dividends payable (liability) were reduced by 1,401 million Dividends payable

Stock Splits and Stock Dividends

Assume that the Carpelli Corporation's board of directors decided to declare a 100 stock dividend instead of the split. Prepare the stockholders' equity section after the stock dividend. How many shares of stock will be issued to the shareholders (Note that for a large stock dividend 100 in this case the dollar amount transferred from retained earnings to contributed capital will be the par value of the stock, instead of the market price.)

Exhibit 152 Selected Dividend Yields and Payout Ratios 1993 and 1999

Dividend Yield Payout Ratio Dividend Yield Payout Ratio Dividend Yield Payout Ratio Dividend Yield Payout Ratio Then the choice between paying dividends and repurchasing shares is a matter of indifference to shareholders. At the end of the year, the firms will each be worth the same amount, XX (after paying dividends or repurchasing shares), which lies somewhere between 100 million and 200 million, depending on industry conditions.

How Dividend Policy Affects Expected Stock Returns

We have asserted that share repurchases provide a better method of distributing cash than dividends because most investors prefer capital gains income to an equivalent dividend taxed at a higher rate. Stocks with higher dividend yields, to compensate investors for their tax disadvantage, should thus offer higher expected returns than similar stocks with lower dividend yields. Firms with higher dividend yields, but equivalent cash flows, should then have lower values, reflecting the higher rates that apply to their cash flows. Researchers have taken two approaches to evaluate the effect of dividend yield on expected stock returns. The first approach measures stock returns around the date that the stock trades ex-dividend. Recall from Chapter 8 that the ex-dividend date (or the ex-date) is the first date on which purchasers of new shares will not be entitled to receive the forthcoming dividend. For example, a dividend paid on February 15 may have an ex-dividend date of February 5, which...

The Cross Sectional Relation between Dividend Yields and Stock Returns

If a firm's dividend policy is determined independently of its investment and operating decisions, the firm's future cash flows also are independent of its dividend policy. In this case, dividend policy can only affect the value of a firm by affecting the expected returns that investors use to discount those cash flows. For example, if dividends are taxed more heavily than capital gains, then, as noted earlier, investors must be compensated for this added tax by obtaining higher pretax returns on high-dividend yielding stocks. (They would not hold shares in such stocks and supply would not equal demand if this were not true.) Stocks with high dividend yields do, in fact, have higher returns, on average, than stocks with low dividend yields. However, Blume (1980) documented that the relationship between returns and dividend yield is actually U-shaped. Stocks with zero dividend yields have substantially higher expected returns than stocks with low dividend yields, but for stocks that do...

Comparing the Corporate Valuation and Dividend Growth Models

Because the corporate valuation and dividend growth models give the same answer, does it matter which model you choose In general, it does. For example, if you were a financial analyst estimating the value of a mature company whose dividends are expected to grow steadily in the future, it would probably be more efficient to use the dividend growth model. Here you would only need to estimate the growth rate in dividends, not the entire set of pro forma financial statements. could make a reasonable estimate of future dividends. Then, because you would have already estimated future financial statements, it would be a toss-up as to whether the corporate valuation model or the dividend growth model would be easier to apply. Intel, which pays a dividend of about 8 cents versus earnings of about 0.54, is an example of a company to which you could apply either model.

Dividend Yield and Expected Capital Gains Yields on Stocks

R dividend yield + expected capital gains yield The dividend yield is directly analogous to the bonds' current yield Dividend yield Now, we can use this formula to directly estimate the expected capital gains yield, but it's usually easier to calculate the dividend yield and then back out the expected capital gains yield by subtracting dividend yield from r. However, since we already had P0, it would have been easier to first calculate dividend yield Dividend yield Expected capital gains yield r - dividend yield

Empirical Evidence on Dividend Policy

We observe several interesting patterns when we look at the dividend policies of firms in the United States in the last 50 years. First, dividends tend to lag behind earnings that is, increases in earnings are followed by increases in dividends, and decreases in earnings sometimes by dividend cuts. Second, dividends are sticky because firms are typically reluctant to change dividends in particular, firms avoid cutting dividends even when earnings drop. Third, dividends tend to follow a much smoother path than do earnings. Finally, there are distinct differences in dividend policy over the life cycle of a firm, resulting from changes in growth rates, cash flows, and project availability.

Annual Dividend Yield SP 500

Jubak, and many other observers, would argue that today's low dividend yields are symptomatic of our overvalued markets. Well, maybe markets are overvalued. But I believe dividend yields are so low for another reason Investors are beginning to ask our childish question Why are there dividends And they're not finding good answers. So dividends are becoming less and less important. More and more investors and companies are seeing it this way. But there was a time when everyone felt like Jubak. In those days, dividend yields on stocks had to be high because investors saw high dividends as compensating for the risk of equity ownership. When dividend yields were low, investors reasoned they'd be better off investing in the same company's bonds. After all, why not earn a higher return with less risk In fact, for most of the last century, the conventional wisdom was that whenever the dividend yield on the stock market fell below the coupon yield of the bond market, it was time to sell...

Dividend Policy at Growth Firms

Assume that you are following a growth firm, whose growth rate has begun easing. Which of the following would you most likely observe in terms of dividend policy at the firm b. No change in dividend policy, and an increase in the cash balance. c. No change in dividend policy, and an increase in acquisitions of other firms Explain.

Comparable Firm Approach to Analyzing Dividend Policy

So far, we have examined the dividend policy of a firm by looking at its cash flows and the quality of its investments. There are managers who believe that their dividend policies are judged relative to those of their competitors. This comparable-firm approach to analyzing dividend policy is often used narrowly, by looking at only firms that are similar in size and business mix, for example. As we will illustrate, it can be used more broadly, by looking at the determinants of dividend policy across all firms in the market.

Step 4 Interaction between Dividend Policy and Financing Policy

The analysis of dividend policy is further enriched and complicated if we bring in the firm's financing decisions as well. In Chapter 9, we noted that one of the ways a firm can increase leverage over time is by increasing dividends or repurchasing stock at the same time, it can decrease leverage by cutting or not paying dividends. Thus, we cannot decide how much a firm should pay in dividends without determining whether it is under- or over-levered and whether or not it intends to close this leverage gap. An underlevered firm may be able to pay more than its FCFE as dividend and may do so intentionally to increase its debt ratio. An overlevered firm, on the other hand, may have to pay less than its FCFE as dividends, because of its desire to reduce leverage. In some of the scenarios described above, leverage can be used to strengthen the suggested recommendations. For instance, an under-levered firm with poor projects and a cash flow surplus has an added incentive to raise dividends...

Cash Flow Approach to Analyzing Dividend Policy

Given what firms are returning to their stockholders in the form of dividends or stock buybacks, how do we decide whether they are returning too much or too little In the cash flow approach, we follow four steps. We first measure how much cash is available to be paid out to stockholders after meeting reinvestment needs and compare this amount to the amount actually returned to stockholders. We then have to consider how good existing and new investments in the firm are. Thirdly, based upon the cash payout and project quality, we consider whether firms should be accumulating more cash or less. Finally, we look at the relationship between dividend policy and debt policy.

Stock Dividend

A stock dividend is the distribution of additional shares of stock to shareholders. Stock dividends are generally stated as a percentage of existing share holdings. For example, if you own 1,000 shares of stock and the firm pays a 5 stock dividend, you receive 5 more shares, or 50 shares. Before the dividend, you own 1,000 shares after the dividend, you own 1,050 shares. If a corporation pays a stock dividend, it is not transferring anything of value to the shareholders. The assets of the corporation remain the same and each shareholder's proportionate share of ownership remains the same. All the firm is doing is cutting its equity pie into more slices and at the same time cutting each shareholder's portion of that equity into more slices. So why pay a stock dividend There are a couple of reasons for stock dividends. One is to provide information to the market. A firm may want to communicate good news to the shareholders without paying cash. For example, if the firm has an attractive...

Cash Dividends

Several issues are important in recording cash dividend transactions. Cash dividends are paid only on shares outstanding. They are not paid on shares held in treasury a company does not pay dividends to itself. Dividends declared during a fiscal period are reported on the statement of stockholders' equity as a reduction in retained earnings. Dividends paid are reported on the corporation's statement of cash flows for that period. Those amounts are not always the same. For example, a company may declare a dividend near the end of its fiscal year but not pay the dividend until the following fiscal year. Dividends declared but not paid are reported as a current liability, Dividends Payable.

Stock Dividends

Corporations sometimes issue stock dividends. Stock dividends are shares of stock distributed by a company to its current stockholders without charge to the stockholders. The effect of a stock dividend is to increase the number of shares of stock a company has outstanding and the number held by each stockholder. The increase in the number of shares held by each stockholder is in proportion to the number that stockholder owned before the distribution. For example, assume that you owned 1,000 shares of Druid Company's stock on June 1, 2004, the date the company distributed a 5 stock dividend. You would receive 50 additional shares (1,000 shares X 5 ). The total number of shares of common stock outstanding increased by 5 as a result of this distribution. Unlike cash dividends, stock dividends do not decrease a company's cash. No cash is paid out. The amount of the stock dividend is subtracted from retained earnings and added to contributed capital. Therefore, the total amount of...

Dividend Policy

With a passive dividend-payout policy, the company pays out as cash dividends any earnings it has left over after funding all worthwhile investment opportunities. It is passive in the sense that there is an automatic decision rule. With an active dividend policy, a company may pay out more in dividends, or conceivably less, in the belief that dividends are relevant in their effect on share value. 2. The investor manufactures homemade dividends by selling shares of stock if the dividend paid is less than the investor's consumption desires and by buying shares if consumption desires are less than the dividend paid. Imperfections impeding such actions include the problem of divisibility of shares, taxes to the investor, transaction costs, and inconvenience costs. In the absence of these factors, the action of a number of investors manufacturing homemade dividends is to make the percentage of dividend payout of a company irrelevant from the standpoint of valuation. the company to retain...

Share Prices and Efficient Markets

Suppose you buy a share of stock of IBM. The price you are willing to pay is the present value of future cash flows you expect from dividends paid on one share of IBM stock and from the eventual sale of that share. This price reflects the amount, the timing, and the uncertainty of these future cash flows. Now what happens if some news good or bad is announced that changes the expected IBM dividends If the market in which these shares are traded is efficient, the price will fall very quickly to reflect that news.

New Material In The Fourth Edition

A recurring theme in this edition of Stocks for the Long Run is that growth does not imply return. This principle can be applied to individual stocks, industries, and even countries. I show the superiority of high-dividend-yield and low-P-E strategies for the stocks in the S& P 500 Index. Sector growth turns out to play only a minor role in determining returns. These findings support the conclusion that value stocks outperform growth stocks in the long run, a phenomenon that has been well documented in the finance literature. have misinterpreted historical evidence on dividend growth and corporate profits.

See Chapters 4 8 9 and

The interest rate sensitivity of equities (the so-called equity duration) has long been a subject of much confusion. The DDMs treat a stock as a bond with a continually growing stream of dividend payouts. With so much of the cash flows back-ended into the future, such models display a very high sensitivity to any change in the discount rate. However, in practice, stocks have tended to display a much more moderate sensitivity to changing interest rates. This discrepancy leads to what is sometimes called the duration paradox Why should the equity market evidence such a low (and relatively unstable) duration when standard models suggest they should have a very high sensitivity to discount rates The FV framework suggests several ways to resolve this paradox. 7. This focus on growth associated with a positive franchise spread leads to a strikingly simpler two-parameter form of the basic three-parameter DDM. In the basic DDM, the three basic parameters are the gross growth rate, the...

Some Examples of the Conflict

Dividend policy is another issue on which a conflict of interest may arise between stockholders and bondholders. The effect of higher dividends on stock prices can be debated in theory, with differences of opinion on whether it should increase or decrease prices, but the empirical evidence is clear. Increases in dividends, on average, lead to higher stock prices, while decreases in dividends lead to lower stock prices. Bond prices, on the other hand, react negatively to dividend increases and positively to dividend cuts. The reason is simple. Dividend payments reduce the cash available to a firm, thus making debt more risky.

The Information Problem

While there is significant anecdotal evidence of this occurrence, the most direct evidence that firms do this comes from studies of earnings and dividend announcements made by firms. A study of earnings announcements, noted that those announcements that had the worst news tended to be delayed the longest, relative to the expected announcement date.17 In a similar vein, a study of earnings and dividend announcements by day of the week for firms on the New York Stock Exchange between 1982 and 1986 found that the announcements made on Friday, especially after the close of trading, contained more bad news than announcements made on any other day of the

Cash Flow to Creditors and Stockholders

The cash flows to creditors and stockholders represent the net payments to creditors and owners during the year. Their calculation is similar to that of cash flow from assets. Cash flow to creditors is interest paid less net new borrowing cash flow to stockholders is dividends paid less net new equity raised.

Valuing Common Stocks

Dividend Discount Model - Computation of today's stock price which states that share value equals the present value of all expected future dividends. Dividend Discount Model - Computation of today's stock price which states that share value equals the present value of all expected future dividends.

Why Not Just Use Dividends

Because the average dividend yield on most stocks has fallen to an all-time low of around 2 percent, you would find yourself wanting if dividends were your sole source of income. The reason stock dividends currently are so low is that most companies and shareholders believe that dividends are a poor use of a corporation's earnings. Shareholders who usually are trying to accumulate wealth would rather have companies either reinvest the dividends into strengthening product lines or expansion. In other words, why distribute dividends when the company could make more money with these funds Add to this the negative tax aspects of corporate dividends (double taxation), and you can see why the trend favors companies not paying dividends. that high dividend-paying stocks are usually in the mature stage of their corporate life cycle or they are companies that stress income over growth.

Assets Equal Liabilities Plus Equity

Like bonds, preferred stock has a par value. The par value is printed on the stock certificate and represents the value of the stock at the time it was issued. Preferred dividends are similar to interest payments when they are fixed and paid at regular intervals. A company usually must pay preferred dividends before paying common dividends. However, a company may defer payment of preferred dividends. This will not lead to bankruptcy, but forgoing interest payments probably will lead to trouble.

And Financial Environments

One advantage to Subchapter S occurs when investors have outside income against which to use losses by the company. Even with no outside income, stockholders still may find Subchapter S to be advantageous. If dividends are paid, the stockholder under Subchapter S is subject only to taxation on the profits earned by the company. Under the corporate method, the company pays taxes on its profits and then the owners pay personal income taxes on the dividends paid to them.

Comparison of Investment Projects

There is a variety of methods for decision making and we will mention only some of the principles. All the methods start with a careful analysis of the expected stream of payments including dividends, interest obtained or paid, salvage value of the assets at the end of the project's life, etc. The cost of capital (the valuation interest rate) should take into account the riskness (uncertainty) of the project.

Agency Costs And Ownership Structure

The social and private costs of an agent's actions due to incomplete alignment of the agent's and owner's interests were brought to attention by the seminal contributions of Jensen and Meckling (1976) on agency costs. Agency theory has also brought the roles of managerial decision rights and various external and internal monitoring and bonding mechanisms to the forefront of theoretical discussions and empirical research. Great strides have been made in demonstrating empirically the role of agency costs in financial decisions, such as in explaining the choices of capital structure, maturity structure, dividend policy, and executive compensation. However, the actual measurement of the principal variable of interest, agency costs, in both absolute and relative terms, has lagged behind.

Disadvantages of Corporations

There are several disadvantages to the corporate form of ownership. Most corporations must pay taxes on their incomes. Corporate taxes are separate from the taxes paid by shareholders on dividends received from the company. (Some corporations, however, especially smaller ones, are not taxed separately.) Another disadvantage is that corporations are regulated by various state and federal government agencies. These regulations require corporations to comply with many state and federal rules concerning business practices and reporting of financial information. Corporations must file many reports with government agencies and make public disclosure of their business activities. Compliance with these regulations is costly. Also, some of the required disclosures may be helpful to competitors. Partnerships and proprietorships are regulated also, but the degree of regulation normally is much less than for corporations.

Environmental Management And Shareholder Value Creation

Firms with poor environmental management, therefore, can be expected to pay higher rates of interest than others, due to the increased risk of environmental liability in the eyes of its investors. This results in a higher cost of debt and larger debt obligations, thus reducing residual earnings that provide a return to equity holders and destroying shareholder value. Return to equity holders consists of dividends paid by the firm as well as the appreciation of the firm's stock price. As with the cost of debt, the perceived level of risk borne by the investor also drives the cost of equity.

In Practice Implied Costs of Equity and Capital

17 Barra, a leading beta estimation service, adjusts betas to reflect differences in fundamentals across firms (such as size and dividend yields). It is drawing on the regression studies that have found these to be good proxies for market risk. Stock price 50 Expected dividends next year (Cost of equity - Expected growth rate)

Valuing the firms shares as the present value of the future anticipated dividends

We start by computing the fair market value of a stock that pays a growing dividend stream. Here is an example which presents most of the logic of our model It is March 2, 2000, and you are thinking of purchasing a share of XYZ Corporation. Here are some facts about the company and its stock You want value XYZ shares by discounting the stream of future anticipated dividends. In predicting the future dividends of XYZ Corp., you assume that the dividends will grow at a rate of 7 per year. Then the future anticipated dividends per share are Dividend today Div0 10.00 The three dots indicate that you think that the dividend stream is very long (when we write down the actual model, we will assume that the dividend stream goes on forever). Suppose you think that the appropriate discount rate for the dividend stream is XYZ's cost of equity rE 15 . Using rE to discount the future anticipated dividends, you get the fair value of the XYZ Corp's stock today (we will denote this by P0 ) valuing...

Case 3 How Market Risk Can Turn into Financial Risk

Jack and Alice were left with a declining portfolio and very little income to live on. Due to rising inflation, Jack and Alice saw banks and credit unions offering high-yielding safe investments. These accounts were offering several times the income that their stock dividends were providing. Fearing that the stock market could go down further, they clenched their teeth and sold off a good portion of their portfolio at a loss to reinvest in higher-yielding and more reliable investments like certificates of deposit and bonds.

Discussion and Conclusion

In conclusion, both researchers and practitioners have studied stock market prediction for many years. Many studies conclude that stock returns can be predicted by some financial and economic variables. To this end, our finding suggests that financial forecasting is always and will remain difficult since such data are greatly influenced by economical, political, international, and even natural events. Obviously, this study covers only fundamental available information, while the technical analysis approach remains intact. It is far from perfect as the technical analysis has been proved to provide invaluable information during stock-price and stock-return forecasting, and to some extent has been known to offer a relative mixture of human, political, and economical events. In fact, there are many studies done by both academics and practitioners in this area. If both technical and fundamental approaches are thoroughly examined and included during the variable relevance analysis modeling,...

Example 612 FRM Exam 1999Question 55Capital Markets

If the Garman-Kohlhagen formula is used for valuing options on a dividend-paying stock, then to be consistent with its assumptions, upon receipt of the dividend, the dividend should be d) Placed into an interest bearing account, paying interest equal to the dividend yield of the stock

Stockholders Equity 2004000

Although preferred shares are sometimes perceived as a ''debt'' of the company without a due date, they are not actually a debt of the company, but rather are part of equity. Because the preferred dividend is not an obligation of the company, unlike the interest paid on long-term debt, these securities are considered to have a higher risk than long-term debt. Because of this higher risk, the dividend yield on preferred stock will usually be higher than the interest rate that the company pays on long-term debt.

How Bad News For The Firm Becomes Good News For Investors

But in the capital markets, bad news for the firm often can be good news for investors who hold onto the stock and reinvest their dividends. If investors become overly pessimistic about the prospects for a stock, the low price enables stockholders who reinvest their dividends to buy the company on the cheap. These reinvested dividends have turned its stock into a pile of gold for those who stuck with Philip Morris.

Exhibit 26 Types of Bond Covenants

Dividend covenants are beneficial in preventing a manager from leaving bondholders penniless by simply liquidating the firm and paying out the liquidation proceeds as a dividend to shareholders. Bondholders view even a partial payment of dividends as a liquidation of a portion of the firm's assets thus, dividends per se are detrimental to bondholders. Simply prohibiting dividends, however, is not likely to be a good policy because it might cause the firm to waste cash by investing in worthless projects instead of using the cash to pay dividends. Kalay (1982) described the typical form of a dividend covenant a formula that defines an inventory of funds available for dividend payments. The inventory will depend on the size of earnings, new funds derived from equity sales, and the amount of dividends paid out so far.

Operating Elementby Element

Finally, element-by-element arithmetic operations are called array operations. To indicate an array operation in MATLAB, precede the operator with a period (.). Addition and subtraction, and matrix multiplication and division by a scalar, are already array operations so no period is necessary. When using array operations on two matrices, the dimensions of the matrices must be the same. For example, given vectors of stock dividends and closing prices,

ETF Share Creation and Redemption

Etf Creation Redemption Mechanism

How do APs know which securities to include in the basket they turn in for a creation unit Each evening, after the markets are closed and the NAV of a fund is known, ETF companies publish a portfolio composition file (PCF). The PCF lists the exact names and quantity of the underlying securities and cash that need to be turned in by an AP to receive one creation unit. Cash is part of the list because it often represents the accumulated stock dividends in a portfolio that have yet to be paid or a portion of the fund that is invested in nonliquid securities.

Nature of accounting capital

Less formally Y income of financial year NAo net assets as shown in the balance sheet at beginning of financial year NAi net assets as shown in the balance sheet at end of financial year Do-i dividends paid and proposed for the financial year. We can illustrate this as follows

How Much Is the Concatenator Business Worth per Share

The second approach discounts the dividends that will be paid when free cash flow turns positive. But you must discount only the dividends paid on existing shares. The new shares issued to finance the negative free cash flows in years 1 to 6 will claim a portion of the dividends paid out later. The value of the existing shares should be 83.9 percent of the present value of each dividend paid after year 6. In other words, they are worth 83.9 percent of PV(horizon value), which we calculated as 22.4 million from the constant-growth DCF formula. Remember, however, that this formula rests on a very strict assumption constant dividend growth in perpetuity. This may be an acceptable assumption for mature, low-risk firms, but for many firms, near-term growth is unsustainably high. In that case, you may wish to use a two-stage DCF formula, where near-term dividends are forecasted and valued, and the constant-growth DCF formula is used to forecast the value of the shares at the start of the...

Adaptation To Different Markets

The dividend q may be different for delta hedging with long or short stock positions. If the stock is held long, q will indeed be the continuous dividend yield but if the stock is held short, q will be the total cash that needs to be paid out on the short position, i.e. continuous dividend plus stock borrowing cost. The theory carries over very simply from that developed for equity the stock simply becomes one unit of the foreign currency. The dividend throw-off is replaced by the foreign currency interest rate. This is a particularly easy substitution to make since interest rates are incurred continuously. In fact the continuous dividend yield Black Scholes model was really first developed for foreign exchange in that context it is often known as the Garman Kohlhagen model.

The Benefits Of Deferring Capital Gains Taxes

Dividends and capital gains to 15 percent. Nevertheless, effective taxes on capital gains are still lower than on dividends since taxes on capital gains are paid only when the asset is sold, not as the gain is accrued. The advantage of this tax deferral is that the return from capital gains accumulates at the higher before-tax rates rather than the after-tax rates as in the case of dividends. I call the advantage of capital gains over dividend income the deferral benefit.4 For long-term investors the advantage of the deferral benefit can be substantial. For example, take two stocks, one yielding 10 percent per year in dividend income and the other yielding 10 percent solely in capital gains. Assume an individual is in a 30 percent taxable bracket, and the capital gains and dividend tax rate is 15 percent. For an untaxed investor, both investments would yield identical 10 percent returns. But the after-tax yield on the dividend-paying stock is 8.5 percent per year, while, if the...

The Measure of Owners Economic Well Being

Investors buy shares of stock in anticipation of future dividends and increases in the market value of the stock. How much are they willing to pay today for this future and hence uncertain stream of dividends They are willing to pay exactly what they believe it is worth today, an amount that is called the present value, an important financial concept explained in Chapter 7. The present value of a share of stock reflects the following factors

Dividends or Earnings Which to Discount

The calculated stock price would be too high were earnings to be discounted instead of dividends. As we saw in our estimation of a firm's growth rate, only a portion of earnings goes to the stockholders as dividends. The remainder is retained to generate future dividends. In our model, retained earnings are equal to the firm's investment. To discount earnings instead of dividends would be to ignore the investment that a firm must make today in order to generate future returns.

Stocks Or Bonds In Taxdeferred Accounts

Yet many of the recent changes in the tax laws argue that investors should do the opposite. Dividends will enjoy the lower tax rates and appreciation on shares will gain the lower capital gains tax advantage only if they are held in taxable accounts. This is because when a tax-deferred account is cashed out at retirement, an individual pays the full ordinary income tax on the entire withdrawal regardless of how much of the accumulation has been realized through capital gains and how much through dividend income.

Estimating the Market Risk Premium

Assuming one knows the composition of the market portfolio, averaging its return over a long historical time series to compute an expected return on the market portfolio has the advantage of generating a better statistical estimate if the market portfolio's expected return also is stable over time. However, some empirical evidence suggests that the mean returns of portfolios like the S& P 500 change over time, providing an argument for the use of a shorter historical time series, although the ten years used in Example 5.9 may be too short. In addition, changes in the expected return of the market portfolio appear to be predictable from variables such as the level of interest rates, the aggregate dividend yield, and the realized market return over the previous three to five years. To the extent that a model predicting the market's expected return is accurate and holds over long periods of time, one should estimate the parameters of such a model with as much historical data as...

Appendix History Of The Tax Code

In 2003 President Bush signed into law legislation that lowered the top rate on capital gains and qualified dividend income to 15 percent. Qualified dividend income must come from taxable enterprises, not flow through organizations such as real estate investment trusts or investment companies.

Statement of Cash Flows

Cfo Cfi Cff

Cash flow from financing (CFF) includes cash received (inflow) for the issuance of debt and equity. As expected, CFF is reduced by dividends paid (outflow). CFO by itself is a good but imperfect performance measure. Consider just one of the problems with CFO caused by the unnatural re-classification illustrated above. Notice that interest paid on debt (interest expense) is separated from dividends paid interest paid reduces CFO but dividends paid reduce CFF. Both repay suppliers of capital, but the cash flow statement separates them. As such, because dividends are not reflected in CFO, a company can boost CFO simply by issuing new stock in order to retire old debt. If all other things are equal, this equity-for-debt swap would boost CFO.

The Dividend Growth Model and the Npvgo Model Advanced

This chapter has revealed that the price of a share of stock is the sum of its price as a cash cow plus the per-share value of its growth opportunities. The Sarro Shipping example illustrated this formula using only one growth opportunity. We also used the growing-perpetuity formula to price a stock with a steady growth in dividends. When the formula is applied to stocks, it is typically called the dividend-growth model. A steady growth in dividends results from a continual investment in growth opportunities, not just investment in a single opportunity. Therefore, it is worthwhile to compare the dividend-growth model with the NPVGO model when growth occurs through continual investing.

Spectrum of Illustrative Firms

Firm A Stable Growth in Earnings and Dividends Firm A holds to a constant-dividend-payout policy and expects earnings to grow at a steady 8 percent a year far into the future. Now, examine the cash flows to an investor in Firm A under the simplifying assumption that the investment is subject to neither risk nor taxes. The investor's return will have three components dividend return, price return, and reinvestment return.3 Because earnings grow at 8 percent and dividend policy remains unchanged, dividends also will grow at 8 percent (see the solid bars in Figure 4.1). Price appreciation is a consequence of the assumptions regarding the firm and use of the DDM for pricing the stock. The DDM implies that, in a static market, price growth will keep pace with dividend growth. Thus, if dividends grow at 8 percent, the stock price will also grow at 8 percent (see the middle bars in Figure 4.1). A new investor who buys Firm A's stock will Dividend yield Firm B's dividend remains constant...

Securities Act of 1933 Exchange Traded Portfolios

The cash from corporate dividends paid in to a grantor trust are immediately paid out to unit investors. That is different from the 1940 Act securities where dividends are held until the end of each quarter. Holding Company Depositary Receipts (HOLDRs) are proprietary products of Merrill Lynch. They are a good example of an exchange traded grantor trust. HOLDRs cover a narrow sector of the market, such as the Biotech (symbol BBH) or Broadband (symbol BDH). HOLDRs are typically invested in a relatively limited number of stocks and are structured in a manner where investors own the underlying stocks in each unit. Owning the underlying stocks allows investors to vote and receive dividends when they are paid by each company. The disadvantage of direct ownership is that investors are inundated with quarterly and annual reports as well as proxy statements from every company in the HOLDRs. Unlike other exchange traded securities, ETN investors will not receive any periodic payments. Nor do...

ETFs Organized as 40 Act Funds

Another restriction in the UIT structure is on the accumulation of dividends paid by stocks in the fund. The UIT manager cannot reinvest cash from dividends paid by the underlying companies in more shares of stock within the security. That cash must go in a non-interest-bearing escrow account where it will sit until paid out to shareholders on a quarterly basis. Vanguard has patented this structure. That means any other open-end mutual fund company can license the concept from Vanguard (as of this writing no other company has). Vanguard ETFs reinvest dividends paid by the underlying securities, which allows the funds to track their indexes more closely.

Corporate Financial Decisions Firm Value and Equity Value

This neat formulation of value is put to the test by the interactions among the investment, financing, and dividend decisions, and the conflicts of interest that arise between stockholders and lenders to the firm, on the one hand, and stockholders and managers, on the other. We introduce the basic models available to value a firm and its equity in chapter 12, and relate them back to management decisions on investment, financial and dividend policy. In the process, we examine the determinants of value and how firms can increase their value.

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