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JMU FIN 345 - Stock dividends

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FIN 345 1st Edition Lecture 20Outline of Current LectureChapter 14a. Discuss the types of dividend payments and payment procedures that firms follow in practice and discuss factors that firms consider when making dividend policy decisionsi. Variations in capital structures among firms: wide variations in use of financial leverage among industries and firms within an industryii. Dividend Policy1. Dividends: payments made to stockholders from the firm’s earnings, whether those earnings were generated in the current period or previous ones2. Dividends affect capital structure: retaining earnings increases common equity relative to debt. Financing with retained earnings is cheaper than issuing new common equity3. Dividend irrelevance theory: theory that a firm’s dividend policy has no effect on either its value or its cost of capital, because investors value dividends and capital gains equally4. Dividend relevance theory: the value of a firm is affected by its dividend policy. Optimal dividend policy is the one that maximizes the firms valueiii. Investors and Dividend Policy1. Information content (Signaling): investors regard dividend changes as signals of managements earnings forecasts2. Clientele effect: the tendency of a firm to attract the type of investor who likes its dividend policy3. Free cash flow hypothesis: firms that pay dividends from cash flows that cannot be reinvested in positive NPV projects have higher values than firms that retain these “free” cash flowsiv. Dividend policy in practice1. Residual dividend policy: dividends are paid from earnings that are notneeded to finance the firm’s optimal capital budget (residual earnings);dividends could fluctuate each year2. Stable, predictable dividend policy: payment of a specific dollar dividend each year or a periodic increase the dividend at a constant rate; dividends will be fairly predictable from on year to the next3. Constant payout ratio: same percentage of earnings- say 50% - is paid out every year; dividends will fluctuate the same as earnings4. Low regular dividend plus extras: a relatively low regular dividend is paid regardless of the firm’s earnings; in times when earnings are high,the firm adds an extra dividend; dividends could fluctuate each yearThese notes represent a detailed interpretation of the professor’s lecture. GradeBuddy is best used as a supplement to your own notes, not as a substitute.5. Declaration date: date on which a firms board of directors issues a statement declaring a dividend6. Holder-of-record date: date on which the company opens the ownership books to determine who will receive the dividend7. Ex-dividend date: date on which the right to the next dividend no longer accompanies the stock when a new investor buys it; two business days prior to the holder-of-record date8. Payment date: the date on which the company actually mails the dividend checks9. Dividend reinvestment plans-DRIPS: a plan that enables a stockholder to automatically reinvest dividends received back into the stock of paying firm; can either be a repurchase of existing shares in the stock market or involve new shares issued by the firmv. Factors influencing dividend policy1. Constraints on dividend payments:a. Debt contract restrictionsb. Cannot exceed “retained earnings”c. Cash availabilityd. IRS restrictions on improperly accumulated retained earnings2. Investment opportunitiesa. Large capital budgeting projects affect dividend-payout ratiosb. More good investment opportunities generally mean less dividends3. Alternative sources of capitala. Flotation costs, increasing capital costs, ownership dilution4. Effects of dividend policy on rsa. Stockholders desire for current versus future incomeb. The perceived riskiness of dividends versus capital gainsc. The ta effects of capital gains versus dividendsd. The information content of dividendsb. Describe stock dividends and stock splits and discuss how stock prices are affected by these actionsi. Stock dividends and Stock splits1. Stock split: an action taken by a firm to increase the number of shares outstanding in an effort to reduce the stock price2. Stock dividend: a dividend paid in the form of additional shares of stock rather than in cash3. Affect on value: neither a stock split nor a stock dividend has economicvalue by itselfc. Describe how and why capital structures vary among firms in the united states and around the worldi. Around the world:1. Companies in Italy and japan use more debt than companies in the US or Canada, but companies in the UK use less than any of these2. Different accounting practices make comparisons difficult3. Gap has narrowed in recent years4. Dividend-payout ratios vary greatly


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