8) Dividends

Question 1

what impact does paying divs have on RE?

Answer 1

• reduces it
• firm cannot use that money to invest in profitable projects
• must issue more shares to inc RE again

Question 2

what does the bird-in-hand theory state?

Answer 2

• dividends have a positive effect on the value

- high expected divs = high company value

Question 3

what does the M&M theory about divs say?

Answer 3

• no impact on company value (irrelevant)

- payments actually reduce growth potential and thus future divs

Question 4

how can an issue of new shares impact SH?

Answer 4

more dilution of control

Question 5

what is the role of dividends?

Answer 5

• increase wealth of owners

- act as profit-creation signals

Question 6

what does agency theory highlight?

Answer 6

the conflicts that arise when mgmt acts in their own interests rather than that of owners

Question 7

what does signaling theory state?

Answer 7

mgmt has more info than investors, and any info they have in common will not be perceived in the same way

Question 8

what is the residual approach for divs?

Answer 8

• suggests divs are paid from what is left over from investments and financing (pay if no inv opportunities)
• is a passive variable

Question 9

what must a company identify to adopt a residual approach?

Answer 9

• its inv opportunities
• required rate of return
• target debt ratio

Question 10

what factors impact the dividend decision?

Answer 10

1) info content of divs
2) nature of SH
3) tax consequences
4) legal requirements
5) contractual obligations

Question 11

what signal does an increase in divs send?

Answer 11

that current earnings and profits are seen to be sustainable

Question 12

when does a company have sustainable earnings?

Answer 12

both earnings and divs increase

Question 13

will companies pay divs when in the growth phase?

Answer 13

no, they will focus on funding growth and investment

Question 14

what is the clientele effect?

Answer 14

a change in share price due to corporate decision-making that triggers investors’ reactions

Question 15

what kind of SH will prefer a low-div company?

Answer 15

prefer growth and capital gains, not divs

Question 16

what kind of SH will prefer a high-div company?

Answer 16

prefer dividends and need the income

Question 17

what are tax consequences of issuing a dividend?

Answer 17

SH will be subject to DWT and not the CGT (if the company had reinvested into itself and increased its value)

Question 18

what are the legal requirements for issuing a dividend?

Answer 18

the Companies Act rules for when making a distribution

Question 19

what are the Companies Act rules for when making a distribution?

Answer 19

1) authorized by BOD by way of resolution (unless they have an existing legal obl)
2) reasonably appears that company will pass S/L tests after making the distribution
3) BOD acknowledges that is has applied the test and concluded it will be satisfied

Question 20

what do we test in the S/L tests?

Answer 20

1) A>L

2) company can pay its debts as they become due for 12 months after the distribution

Question 21

what is commercial solvency?

Answer 21

A > L (FVs)

Question 22

what is factual solvency?

Answer 22

company can pay its debts as they become due for 12 months after the distribution

Question 23

what contractual obligations can impact the issue of dividends?

Answer 23

company may have entered into contracts which limit its ability to pay divs (loan covenants)

Question 24

what must the div policy do?

Answer 24

dictate how much cash is returned to SH

Question 25

what must the div policy not do?

Answer 25

result in div payments which change significantly from year-to-year

Question 26

what is the stable payout dividend?

Answer 26

same amount payout every year regardless of earnings

Question 27

what is the stable payout ratio/cover?

Answer 27

• fixed proportion of earnings paid out each year

- uses DPS/EPS as ratio

Question 28

what is special dividend?

Answer 28

company maintains a consistent payout ratio but pays special dividend when earnings/CF are high

Question 29

what is stable plus bonus payout method?

Answer 29

low annual dividend (fixed) and pays special bonus depending on performance for the year

Question 30

which payout method is suitable for companies with volatile trading conditions?

Answer 30

stable plus bonus

Question 31

when is the ex-dividend date?

Answer 31

4 days before record date

Question 32

what is the ex-dividend date?

Answer 32

if an investor purchases a share before this date, they will get the dividend; if not, no div

Question 33

what is cum dividend?

Answer 33

with dividend

Question 34

what is ex-dividend?

Answer 34

without dividend

Question 35

what is a capitalization issue?

Answer 35

allotment of additional shares to existing SH at no cost to them

Question 36

do cap issues/share splits impact value?

Answer 36

no