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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...

In Spite Of The Theoretical Argument That Dividend Policy Should Be Irrelevant The Fact Remains That Many Investors

Clienteles 515 Date of payment 497 Date of record 496 Declaration date 496 Ex-dividend date 496 Homemade dividends 501 Information-content effect 514 Regular cash dividends 495 Stock dividend 496 Stock split 496 Ross-Westerfield-Jaffe IV. Capital Structure and Corporate Finance, Sixth Dividend Policy Edition 1S. Dividend Policy Why Does It Matter Chapter 18 Dividend Policy Why Does It Matter The breakthrough in the theory of dividend policy is contained in Miller, M., and F. Modigliani. Dividend Policy, Growth and the Valuation of Shares. Journal of Business (October 1961). A survey of dividend policy can be found in Allen, Franklin, and Roni Michaely. Dividend Policy. In R. A. Jarrow, V. Maksimovic, and W. T. Ziemba (eds.). Handbooks in Operations Research and Management Science Finance. Amsterdam Elsevier Science (1995), 793-838. Current trends in dividend policy are examined in The Mechanics of Dividend Payouts a. What will be the price of the stock on the ex-dividend date if 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

Growth Stocks and Income Stocks

We often hear investors speak of growth stocks and income stocks. They seem to buy growth stocks primarily in the expectation of capital gains, and they are interested in the future growth of earnings rather than in next year's dividends. On the other hand, they buy income stocks principally for the cash dividends. Let us see whether these distinctions make sense.

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

Dividend Policies of Selected US Firms

Exhibit 15.2 provides a representative sample of well-known U.S. corporations and their dividend yields, the ratio of the dividend per share to the price per share, and dividend payout ratios, the ratio of the dividend per share to the earnings per share (income before extraordinary items) for 1993 and 1999. The exhibit reveals major differences in the dividend policies of various types of firms. The high-tech growth firms have both low dividend yields and low payout ratios. In 1999, Microsoft and Apple paid no dividends while Hewlett-Packard had a payout ratio of about 20 percent and a yield of less than 1 percent. However, the old economy companies like Deere, Dow Chemical, Minnesota Mining & Manufacturing, Philip Morris, and Texaco pay out over half of their earnings in dividends. Also note from Exhibit 15.2 that both dividend yields and payout ratios have fallen for most firms. This is partly due to the continuing trend of firms substituting share repurchases for dividends.

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...

Dividends and Dividend Policy

In December 1999, General Electric Company (better known as GE) announced a broad plan to reward stockholders for the recent success of the firm's business. Under the plan, GE would (1) boost its quarterly dividend by 17 percent from 35 cents per share to 41 cents per share, (2) expand its plans to buy back its common stock by as much as 5 billion, and (3) undertake a three-for-one stock split, meaning that each existing common share would be replaced with three new ones. Investors cheered, bidding the stock price up by 2.9 percent on the day of the announcement. Why were investors so pleased To find out, this chapter explores all three of these actions and their implications for shareholders. Dividend policy is an important subject in corporate finance, and dividends are a major cash outlay for many corporations. In 1995 alone, for example, New York Stock Exchange-listed firms paid out in excess of 130 billion in cash dividends. At the same time, however, about 25 percent of the...

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.

An Illustration of the Irrelevance of Dividend Policy

A powerful argument can be made that dividend policy does not matter. We illustrate this by considering the simple case of Wharton Corporation. Wharton is an all-equity firm that has existed for 10 years. The current financial managers plan to dissolve the firm in two years. The total cash flows the firm will generate, including the proceeds from liquidation, will be 10,000 in each of the next two years. Current Policy Dividends Set Equal to Cash Flow At the present time, dividends at each date are set equal to the cash flow of 10,000. There are 100 shares outstanding, so the dividend per share is 100. In Chapter 6, we showed that the value of the stock is equal to the present value of the future dividends. Assuming a 10 percent required return, the value of a share of stock today, P0, is 18. Dividends and Dividend Policy

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...

Some Details on Stock Splits and Stock Dividends

Stock splits and stock dividends have essentially the same impacts on the corporation and the shareholder they increase the number of shares outstanding and reduce the value per share. The accounting treatment is not the same, however, and it depends on two things (1) whether the distribution is a stock split or a stock dividend and (2) the size of the stock dividend if it is called a dividend. By convention, stock dividends of less than 20 to 25 percent are called small stock dividends. The accounting procedure for such a dividend is discussed next. A stock dividend greater than this value of 20 to 25 percent is called a large stock dividend. Large stock dividends are not uncommon. For example, in 2000, Corning announced a 200 percent stock dividend, and, in 1999, biotechnology company Amgen announced a 100 percent stock dividend, to name a few. Except for some relatively minor accounting differences, this has the same effect as a two-for-one stock split. Example of a Small Stock...

Dividend policies and Stock Buyback Restrictions

Some countries do not allow firms to buy back stock from their stockholders. Which of the following would you expect of dividend policies in these countries (relative to countries that don't restrict stock buybacks) Illustration 10.1 Dividends, Dividend Yields and Payout Ratios In the illustration that follows, we will examine the dollar dividends paid at Disney, Aracruz and Deutsche Bank between 2001 and 2003. Each year, we will also compute the dividend yield and dividend payout ratio for each firm.

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.

Dividend Clientele and Changing Dividend Policy

Phone companies in the United States have for long had the following features - they are regulated, have stable earnings, low reinvestment needs and pay high dividends. Many of 14 Black, F. and M. Scholes, 1974, The Effects of Dividend Yield and Dividend Policy on Common Stock Prices and Returns, Journal of Financial Economics, v1, 1-22. b. continue to pay high dividends, and use new stock issues to finance the expansion

Dividend Yields Around the World

Dividend yields vary considerably in different stock markets throughout the world. In 1999 in the United States, dividend yields averaged 1.6 percent for the large blue chip stocks in the Dow Jones Industrials, 1.2 percent for a broader sample of stocks in the S&P 500, and 0.3 percent for Dividend yields vary considerably in different stock markets throughout the world. In 1999 in the United States, dividend yields averaged 1.6 percent for the large blue chip stocks in the Dow Jones Industrials, 1.2 percent for a broader sample of stocks in the S&P 500, and 0.3 percent for stocks in the high-tech-dominated Nasdaq. Outside the United States, average dividend yields ranged from 5.7 percent in New Zealand to 0.7 percent in Taiwan. The accompanying table summarizes the dividend picture in 1999. stocks in the high-tech-dominated Nasdaq. Outside the United States, average dividend yields ranged from 5.7 percent in New Zealand to 0.7 percent in Taiwan. The accompanying table summarizes the...

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

Agency theory view of dividend policy

Market monitoring of the firm's activities and performance.The reason is that higher dividend payouts increase the likelihood that the firm will have to sell common stock in primary capital markets. This in turn leads to an investigation of management by investment banks, securities exchanges and capital suppliers. Studies by Baghat (1986), Smith (1986), Hansen and Torregrosa (1992) and Jain and Kini (1999) have recognised the importance of monitoring by investment bankers in new equity issues. Recent theoretical work by Fluck (1998), and Myers (2000) also presents agency-theoretic models of dividend behaviour where managers pay dividends in order to avoid disciplining action by shareholders. In Rozeff's (1982) model, an optimal dividend policy is the outcome of a trade-off between equity agency costs and transaction costs. Consistent with such trade-off model, Rozeff reports evidence of a strong relationship between dividend payouts and a set of variables proxying for agency and...

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...

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....

Empirical Evidence on Stock Returns at the Time of Dividend Announcements

When firms announce dividend increases, their stock prices generally increase about 2 percent see Aharony and Swary (1980) . Announcements of the initiation of quarterly dividend payouts by firms that previously paid no dividends generate even larger stock price reactions see Asquith and Mullins (1983), Healy and Palepu (1988), and Michaely, Thaler, and Womack (1995) . Moreover, stock prices generally experience similar declines when firms announce dividend decreases or omissions, falling about 9.5 percent, on average, at the announcement of an omission Healy and Palepu (1988) .

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.

The Benchmark Case An Illustration of the Irrelevance of Dividend Policy

Homemade Dividends Graph

A powerful argument can be made that dividend policy does not matter. This will be illustrated with the Bristol Corporation. Bristol is an all-equity firm that has existed for 10 years. The current financial managers know at the present time (date 0) that the firm will dissolve in one year (date 1). At date 0 the managers are able to forecast cash flows with perfect certainty. The managers know that the firm will receive a cash flow of 10,000 immediately and another 10,000 next year. They believe that Bristol has no additional positive NPV projects it can use to its advantage.4 To simplify the example, we assume that the ex-dividend date is the same as the date of payment. After the imminent dividend is paid, the stock price will immediately fall to 9.09 ( 19.09 10). Several members of the board of Bristol have expressed dissatisfaction with the current dividend policy and have asked you to analyze an alternative policy. Another policy is for the firm to pay a dividend of 11 per share...

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...

Value of Stock Splits and Stock Dividends

The laws of logic tell us that stock splits and stock dividends can (1) leave the value of the firm unaffected, (2) increase its value, or (3) decrease its value. Unfortunately, the issues are complex enough that one cannot easily determine which of the three relationships holds. The Benchmark Case A strong case can be made that stock dividends and splits do not change either the wealth of any shareholder or the wealth of the firm as a whole. In our preceding example, the equity had a total market value of 660,000. With the small stock dividend, the number of shares increased to 11,000, so it seems that each would be worth 660,000 11,000 60. For example, a shareholder who had 100 shares worth 66 each before the dividend would have 110 shares worth 60 each afterwards. The total value of the stock is 6,600 either way so the stock dividend doesn't really have any economic effect. After the stock split, there are 20,000 shares outstanding, so each should be worth 660,000 20,000 33. In...

What do managers believe about dividend policy

Given the pros and cons for paying dividends, and the lack of a consensus on the effect of dividends on value, it is worth considering what managers factor in when they make dividend decisions. Baker, Farrely and Edelman (1985) surveyed managers on their views on dividend policy and reported the level of agreement with a series of statements. Table 10.3 summarizes their findings - Table 10.3 Management Beliefs about Dividend Policy Table 10.3 Management Beliefs about Dividend Policy 1. A firm's dividend payout ratio

An Illustration of the Drre Oevance of Dividend Policy

A powerful argument can be made that dividend policy does not matter. We illustrate this by considering the simple case of Wharton Corporation. Wharton is an all-equity firm that has existed for 10 years. The current financial managers plan to dissolve the firm in two years. 'Ihe total cash flows the firm will generate, including the proceeds from liquidation, are SI0.000 in each of the next two years. equal to the present value of the future dividends. Assuming a 10 percent required return, the value of a share of stock today, P,h is Several members of the board of Wharton have expressed dissatisfaction with the current dividend policy and have asked you to analyze an alternative policy. What is the value of the firm with this new dividend policy The new stockholders invest 1,000. They require a 10 percent return, so they will demand 1,000 X 1.10 1,100 of the Date 2 cash How, leaving only 8,900 to the old stockholders. The dividends to the old stockholders will be The value of the...

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

One interpretation of a low dividend yield is that people became more optimistic about longrun economic growth and the

Either of these forces could account for a decline in the dividend yield during the 1990s. We will consider the risk premium issues in more detail shortly. But another explanation is that stock prices were just far ahead of their fundamental value by the end of the 1990s for some reason, share prices had become higher than would be predicted by companies' earnings. In the light of the large falls in stock prices in 2001 and 2002, this now looks more likely.

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.

Example 154 The Decision to Purchase Stock Before or After the ExDividend Date

Trevtex Corporation plans to pay a dividend of 1 per share. Tomorrow is the ex-dividend date, so investors who purchase the stock tomorrow will not receive the dividend. Assume Trevtex is selling for 20.00 per share today and is expected to sell for 19.20 per share tomorrow. Should an investor with a 33 percent marginal tax rate, who is not taxed on capital gains, purchase the stock today and receive the dividend or should the investor wait one day and purchase it without the dividend Answer The net cost per share of buying the stock with the dividend is 20 minus 1 for the dividend plus the tax the investor must pay on the imminent dividend. For an investor with a 33 percent marginal tax rate, this net cost is 19.33 per share. Hence, purchasing the stock ex-dividend for 19.20 per share would be preferred to purchasing the stock for 20 per share just prior to the ex-dividend date, which has a net cost of 19.33. However, a tax-exempt investor would prefer to purchase the stock prior to...

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.

Dividend Payout and Earnings Retention

As we have seen in various places, a firm's net income gets divided into two pieces. The first piece is cash dividends paid to stockholders. Whatever is left over is the addition to retained earnings. For example, from Table 3.3, Prafrock's net income was 363, of which 121 was paid out in dividends. If we express dividends paid as a percentage of net income, the result is the dividend payout ratio Dividend payout ratio Cash dividends Net income 121 363 33Va Notice that net income must be either paid out or plowed back, so the dividend payout and plowback ratios have to add up to 1. Put differently, if you know one of these figures, you can figure the other one immediately.

Payment of Cash Dividends 46000

The board of directors of Metropolitan Manufacturing Company voted to pay the holders of preferred and common shares cash dividends amounting to 46,000. Such dividends are traditionally but not necessarily voted on and disbursed on a quarterly basis. Notice that Retained Earnings on the balance sheet (line 21) was affected by two activities, net income and cash dividends, as follows Minus Cash Dividends, 2002 - 46,000

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...

Other Dividend Yield Strategies

There are other high-dividend-yield strategies that have outperformed the market. A well-known one is called the Dogs of the Dow, or the Dow 10 strategy, and is chosen from high-yielding stocks in the Dow Jones Industrial Average. 13 John R. Dorfman, Study of Industrial Averages Finds Stocks with High Dividends Are Big Winners, Wall Street Journal, August 11, 1988, p. C2.

Determining dividend payout

To find the dividend payout ratio, divide yearly dividend per share (the total amount per share paid out to investors during the year in dividends) by earnings per share Yearly dividend per share * Earnings per share Dividend payout ratio U** You can use numbers from Mattel's 2007 income statement to practice calculating the dividend payout ratio 0.75 (Dividends per share) * 1.54 (Diluted EPS) 48.7 (Dividend payout ratio) Following are numbers from Hasbro's 2007 income statement. You can use them to calculate the dividend payout ratio. 0.64 (Dividends per share) * 1.97 (Diluted EPS) 32.5 (Dividend payout ratio)

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.

Decomposing the Dividend Discount Model

For example, when k 12 percent, g 8 percent, and d 8 million, the stock price is 200 million and the dividend yield is 4 percent. Thus, over a one-year period, the 12 percent return comprises a 4 percent dividend yield and an 8 percent growth rate. Dividend payout ratio Dividend growth rate

Multiperiod Dividend Discount Models

Gordon Growth Model Chart

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. A Proof of the Miller-Modigliani Theorem. To understand Result 15.1, consider two similar equity-financed biotech firms with different dividend policies 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. Although the above example assumes that the year-end value was 150 million for both Signetics and Comgen, the equivalence between dividends and share repurchases holds regardless of the firms' year-end values, as long as it is the same for the two firms. The future values of these two corporations are assumed to perfectly track each other regardless of their dividend policies. Thus, the two firms, which...

How Taxes Affect Dividend Policy

Personal taxes on dividends can profoundly affect a firm's choice between paying dividends and repurchasing shares. Because the pretax proceeds from both strategies are equal, the only difference between the two methods of cash distribution is the amount of the tax liability generated by each. 6Until 1982, the tax on dividend income in the United States could be as high as 70 percent while capital gains were taxed at 50 percent of the ordinary rate. With the passage of the Tax Equity and Fiscal Responsibility Act of 1982, the maximum tax on dividends fell to 50 percent and that on capital gains was reduced to 20 percent. Since 1987, the maximum tax rate on dividends has fluctuated between 33 percent and 39.6 percent, while the rate on capital gains has fluctuated between 20 percent and 28 percent. Under the 2001 tax bill, the highest rate on ordinary income is scheduled to decline in increments to 35 percent by 2006. Can Individual Investors Avoid the Dividend Tax Miller and Scholes...

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...

The Dividend Growth Model Applied to Magna Vision

MagnaVision has not yet begun to pay dividends. However, as we saw in Table 12-1, a cash dividend of 0.442 per share is forecasted for 2005. The dividend is expected to grow by about 2.5 percent in 2006, and then at a constant 5 percent rate thereafter. MagnaVision's cost of equity is 14 percent. In this situation, we can apply the noncon-stant dividend growth model as developed earlier in Chapter 5. Figure 12-3 shows that the value of MagnaVision's stock, based on this model, is 3.70 per share, which is the same as the value found using the corporate valuation model except for a rounding difference.

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.

Differences in Dividend Policy across Countries

Figures 10.5 to 10.8 showed several trends and patterns in dividend policies at U.S. companies.4 They share some common features with firms in other countries, and there are some differences. As in the United States, dividends in other countries are sticky and follow earnings. However, there are differences in the magnitude of dividend payout ratios across countries. Figure 10.9 shows the proportion of earnings paid out in dividends in the G-7 countries in 1982-84 and again in 1989-91. 3. Differences in Corporate Control When there is a separation between ownership and management, as there is in many large publicly traded firms, and where stockholders have little control over managers, the dividends paid by firms will be lower. Managers, left to their own devices, have a much greater incentive to accumulate cash than do stockholders. Not surprisingly, the dividend payout ratios of companies in emerging markets are much lower than the dividend payout ratios in the G-7 countries. The...

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.

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

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 Yields

Graham and Dodd's claim has been supported by more recent research. In 1978, Krishna Ramaswamy and Robert Litzenberger established a significant correlation between dividend yield and subsequent returns.11 And more recently, James O'Shaughnessy has shown that in the period 1951 through 1994, the 50 highest-dividend-yielding large-capitalization stocks had a 1.7 percentage point higher return than the market.12 The historical analysis of the S&P 500 Index supports the case for using dividend yields to obtain higher stock returns. Using December 31 of each year from 1957 onward, I sorted the firms in the S&P 500 Index into five groups (or quintiles) ranked from the highest to the lowest dividend yields, and then I calculated the total returns over the next calendar year. The striking results are shown in Figure 9-2. In strictly increasing order, the portfolios with higher dividend yields offered investors higher total returns than portfolios of stocks with lower dividend yields. If an...

Cash Dividends

Cash dividends are payments made directly to shareholders in proportion to the shares they own. Cash dividends are paid on all outstanding shares of stock. That means no dividends are paid on treasury stock. Cash dividends can be paid monthly, quarterly, semiannually, or annually though most U.S. corporations that pay dividends do so on a quarterly basis. A few companies pay special or extra dividends occasionally identifying these dividends apart from their regular dividends. We usually describe the cash dividends that a company pays in terms of dividends per share (DPS). For example, during 2001 General Electric paid 2,848 million in common dividends on the 9,925 million common shares outstanding. Therefore, General Electric paid 0.64 in dividends per share of stock. We can calculate the DPS as . . , , , Common stock dividends , * n If you owned 10,000 shares of General Electric stock during 2001, you would have received cash dividends of 0.64 per share time 100 shares 6,400....

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...

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

A dividend policy is a firm's decision about the payment of cash dividends to shareholders. Looking at the dividends per share and the dividend payout at a point in time doesn't tell us much about the firm's dividend policy. We generally need somewhat more information than one quarter's or one year's dividend. If we look at dividends over a longer period, we can begin to get a better picture of the firm's dividend policy. There are several basic ways of describing a firm's dividend policy Low regular dividends with periodic extra dividends A common pattern of cash dividends tends to be the constant growth of dividends per share. As we see for Cooper Tire and Rubber in Exhibit 16.2, dividends per share grew at a constant rate after 1986 and until 1999. EXHIBIT 16.3 Dividends per Share and Dividend Payout for the Sara Lee Corporation, 1980-2001 EXHIBIT 16.3 Dividends per Share and Dividend Payout for the Sara Lee Corporation, 1980-2001 Another pattern is the constant payout ratio, as...

Description Of The Fundamental Concept

The franchise value approach was developed out of an effort to value a generic company. Our approach was built on the standard Dividend Discount Model (DDM) together with its enhancements through the work of Williams (1938), Gordon (1962), Miller-Modigliani (1961), and Estep

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.

Tampa Manufacturing Ebit

Preferred Stock Dividends 511 Calculating the Cost of Preferred Stock 511 Review Question 512 Dividend Policy page 598 13.2 Relevance of Dividend Policy 603 13.3 Factors Affecting Dividend Policy 607 13.4 Types of Dividend Policies 611 Policy 611 Regular Dividend Policy 611 low-Regular-and-Extra Dividend Stock Dividends 613 Stock Splits 615 Stock Repurchases 616 IN PRACTICE Focus on Ethics Are Buyfaacks Really a Bargain 618 Chapter 13 Case Establishing General Access Company's Dividend Policy and Initial Dividend 629

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.

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.

Firm Value Today is All Inflows and All Outflows

Dividend Payout The same argument applies to dividends in the end, all earnings must be paid out (i.e., as T'm'around stoo dividends). This does not need to occur at the same time your earnings can grow today, and your dividends can be zero or be shrinking today. In our earlier example, firm G could be a slow dividend payer or a fast dividend payer. It could pay 100 now, 150 nextyear and 250 in two years. Or, it could reinvest the money, effectively on your behalf, (at the same 10 , of course), and then pay one big lump sum dividend of 100- (1 + 10 )2 + 150 - (1 +10 ) + 250 536 at the end of period 2. The dividend payout policy does not affect G's value today. The important point is that the net present value of your total earnings and your total dividends must both be equal to the price of the firm in a perfect world or you would get something for nothing or lose something for nothing. This simple insight is the basis of the Modigliani-Miller (M&M) theorems, which won two Nobel...

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.

Explain Why Each Of The Following Situation Is An Agency Problem And What Costs To The Firm

Q5I Interest versus dividend income During the year just ended, Shering Distributors, Inc., had pretax earnings from operations of 490,000. In addition, during the year it received 20,000 in income from interest on bonds it held in Zig Manufacturing and received 20,000 in income from dividends on its.5 common stock holding in Tank Industries, Inc. Shering is in the 40 tax bracket and is eligible for a 70 dividend exclusion on its Tank Industries stock. c. Find the tax and the after-tax amount attributable to the dividend income from the Tank Industries, Inc., common stock. d. Compare, contrast, and.discuss the after-tax amounts resulting from the interest income and dividend income calculated in parts b and c. Interest versus dividend expense Michaels Corporation expects earnings before interest and taxes to be 40,000 for this period. Assuming an ordinary tax rate of 40 , compute the firm's earnings after taxes and earnings available for common stockholders (earnings after taxes and...

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.

Sales Driven Franchise Value

In a series of earlier papers, published together in 1994, Leibowitz and Kogelman developed a franchise value (FV) approach for estimating the intrinsic value of a firm's equity. Although derived from the standard formulations of the dividend discount model (Williams 1938 Miller and Modigliani 1961 Gordon 1962), the FV approach has the powerful advantage of being a more general (as well as more intuitive) formulation. This greater generality is helpful in adopting the FV model to today's global capital markets, where capital availability is often not the scarce resource (Bernstein 1956 Solnik 1996). Moreover, the FV model's focus on the price earnings ratio (P E) allows exploration of many facets of this key market variable a variable that is widely used in practice but all too little studied from an analytical viewpoint. Even though the original FV devel-

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.

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