PowerPoint PresentationKey Concepts and SkillsChapter Outline16.1 Different Types of Dividends16.2 Standard Method of Cash DividendProcedure for Cash DividendPrice Behavior16.3 The Irrelevance of Dividend PolicyHomemade DividendsA TestDividend Policy is IrrelevantDividends and Investment Policy16.4 Repurchase of StockExample: Stock Repurchase versus DividendSlide 15Slide 16Share Repurchase16.5 Personal Taxes, Issuance Costs, and DividendsFirms without Sufficient CashFirms with Sufficient CashTaxes, Issuance Costs, and Dividends16.6 Real World Factors Favoring High DividendsSignaling16.7 The Clientele Effect16.8 What We Know and Do Not KnowPutting It All Together16.9 Stock DividendsStock SplitsQuick Quiz16-1DIVIDENDS AND OTHER PAYOUTSChapter 16Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.16-2KEY CONCEPTS AND SKILLS•Differentiate and explain various dividend types and how they are paid•Grasp and apply the issues surrounding dividend policy decisions•Comprehend and explain why share repurchases are an alternative to dividends•Distinguish the difference between cash and stock dividends16-3CHAPTER OUTLINE16.1 Different Types of Dividends16.2 Standard Method of Cash Dividend Payment16.3 The Benchmark Case: An Illustration of the Irrelevance of Dividend Policy16.4 Repurchase of Stock16.5 Personal Taxes, Issuance Costs, and Dividends16.6 Real World Factors Favoring a High-Dividend Policy16.7 The Clientele Effect: A Resolution of Real World Factors?16.8 What We Know and Do Not Know About Dividend Policy16.9 Putting It All Together16.10 Stock Dividends and Stock Splits16-416.1 DIFFERENT TYPES OF DIVIDENDS•Many companies pay a regular cash dividend.•Public companies often pay quarterly.•Sometimes firms will pay an extra cash dividend.•The extreme case would be a liquidating dividend.•Companies will often declare stock dividends.•No cash leaves the firm.•The firm increases the number of shares outstanding.•Some companies declare a dividend in kind.•Wrigley’s Gum sends a box of chewing gum.•Dundee Crematoria offers shareholders discounted cremations.16-516.2 STANDARD METHOD OF CASH DIVIDENDRecord Date – Date on which company determines existing shareholders.Ex-Dividend Date - Date that determines whether a stockholder is entitled to a dividend payment; anyone holding stock immediately before this date is entitled to a dividend.Cash Dividend - Payment of cash by the firm to its shareholders.16-6PROCEDURE FOR CASH DIVIDEND25 Oct. 1 Nov. 2 Nov. 5 Nov. 7 Dec.Declaration DateCum-dividend DateEx-dividend DateRecord DatePayment Date…Declaration Date: The Board of Directors declares a payment of dividends.Cum-Dividend Date: Buyer of stock still receives the dividend.Ex-Dividend Date: Seller of the stock retains the dividend.Record Date: The corporation prepares a list of all individuals believed to be stockholders as of 5 November.16-7PRICE BEHAVIOR•In a perfect world, the stock price will fall by the amount of the dividend on the ex-dividend date.$P$P - divEx-dividend DateThe price drops by the amount of the cash dividend. -t …-2 -1 0 +1 +2 …Taxes complicate things a bit. Empirically, the price drop is less than the dividend and occurs within the first few minutes of the ex-date.16-816.3 THE IRRELEVANCE OF DIVIDEND POLICY•A compelling case can be made that dividend policy is irrelevant.•Since investors do not need dividends to convert shares to cash; they will not pay higher prices for firms with higher dividends.•In other words, dividend policy will have no impact on the value of the firm because investors can create whatever income stream they prefer by using homemade dividends.16-9HOMEMADE DIVIDENDS•Bianchi Inc. is a $42 stock about to pay a $2 cash dividend.•Bob Investor owns 80 shares and prefers a $3 dividend.•Bob’s homemade dividend strategy:•Sell 2 shares ex-dividend Cash from dividend $160Cash from selling stock $0Total Cash 160Value of Stock Holdings $40 × 80 =$3,200 $2 Dividend $3 Dividend$160$80$240$40 × 78 =$3,120Total Value Cash & Stocks $3,360 $3,36016-10A TEST•True or False: Dividends are irrelevant•True or False: Dividend policy is irrelevant16-11DIVIDEND POLICY IS IRRELEVANT•In the above example, Bob Investor began with a total wealth of $3,360:share42$shares 80360,3$ 160$share40$shares 80360,3$ 80$160$share40$shares 78360,3$ -After a $2 dividend, his total wealth is still $3,360:-After a $3 dividend and sale of 2 ex-dividend shares, his total wealth is still $3,360:16-12DIVIDENDS AND INVESTMENT POLICY•Firms should never forgo positive NPV projects to increase a dividend (or to pay a dividend for the first time).•Recall that one of the assumptions underlying the dividend-irrelevance argument is: “The investment policy of the firm is set ahead of time and is not altered by changes in dividend policy.”16-1316.4 REPURCHASE OF STOCK•Instead of declaring cash dividends, firms can rid themselves of excess cash through buying shares of their own stock.•Recently, share repurchase has become an important way of distributing earnings to shareholders.•During the financial crisis of 2007 and 2008 share repurchases and dividends exceeded reported earnings16-1416-14EXAMPLE: STOCK REPURCHASE VERSUS DIVIDEND$10=/100,000$1,000,000=Price per share100,000=outstanding Shares1,000,000Value of Firm1,000,000Value of Firm1,000,000Equity850,000 AssetsOther 0Debt$150,000Cashsheet balance Original A.Equity &Liabilities AssetsConsider a firm that wishes to distribute $100,000 to its shareholders.16-1516-15EXAMPLE: STOCK REPURCHASE VERSUS DIVIDEND$9=00,000$900,000/1 = shareper Price100,000=goutstandin Shares900,000Firm of Value900,000Firm of Value900,000Equity850,000AssetsOther 0Debt$50,000Cashdividendcash shareper $1After B.Equity & sLiabilitie AssetsIf they distribute the $100,000 as a cash dividend, the balance sheet will look like this:16-1616-16EXAMPLE: STOCK REPURCHASE VERSUS DIVIDENDAssets Liabilities & EquityC. After stock repurchaseCash $50,000 Debt 0Other Assets 850,000 Equity 900,000Value of Firm 900,000 Value of Firm 900,000Shares outstanding= 90,000Price per share = $900,000 / 90,000 = $10If they distribute the $100,000 through a stock repurchase, the balance sheet will look like this:16-17SHARE REPURCHASE•Flexibility for