Analysis Of Dividends & Share Repurchases Flashcards
When will the price of a stock be lowered to account for the dividend payout?
- it will trade lower by the amount of the dividend on the ex-dividend date
What are the 4 different types of dividends? RELS
- regular cash dividends: regularly scheduled dividends
- extra or special (irregular) dividends: when company is performing well
- liquidating dividends: return of capital if company goes out of business
- stock dividends: instead of cash dividends you receive stock dividends
What are stock splits?
- stock splits: spitting one share into multiple shares, often announced after stock has risen in value to keep price within a desirable range
What are 3 circumstances would cause a dividend to be classified as a liquidating dividend?
-company goes out of business and distributes its net assets to shareholders.
-portion of a business is sold and the proceeds are distributed to shareholders.
-amount of the dividend exceeds the value of the company’s accumulated retained earnings.
How does a cash dividend vs a stock dividend affect liquidity and leverage ratios?
- cash dividends reduce liquidity ratios and increase leverage
- stock dividends don’t affect company balance sheet or income statement so liquidity and financial leverage ratios remain unchanged
What is Modigliani and Miller’s view on dividend policy?
Dividend policy doesn’t matter
- dividend policy will not impact the price of a company’s stock or its cost of capital in a perfect capital market with no taxes, no transaction costs, and symmetric information among all investors.
What is the bird in hand argument on dividend policy?
- investors would prefer a dollar of dividends over a dollar of potential capital gains because dividends are less risky
- Shareholders would require a lower return from companies that pay dividends. This lowers the cost of capital for those companies, thereby increasing their share prices.
What is the tax argument viewpoint of dividend policy?
- Many countries tax dividends at a higher rate than capital gains, therefore they would rather small or no dividend
What is dividend action signaling?
- company’s either increase or reduce dividends often means management is signaling its confidence that there will be sufficient cash flows to make these payments or the opposite.
What are the 6 factors that have significant impact on a company’s dividend policy?
- Investment Opportunities: may reduce dividends to invest in projects
- Volatility of future earnings: managers focus on sustainable dividends instead of short term volatile dividends
- Financial flexibility
- Tax considerations
- Flotation costs: costs incurred when issuing new shares (eg. Investment banking fees)
- Contractual /legal restrictions (eg. Brazil requires dividend payments)
What is double tax and formula?
- companies are taxed on their pretax earnings and shareholders then are taxed on the dividends that are paid
Corporate tax rate + (1-corporate tax rate)(individual tax rate)
What is dividend imputation? And how does it work (eg. If 25% tax rate for corporate and 45% tax rate for shareholder.)
- Dividend imputation is the process of eliminating double taxation on cash payouts from companies to their shareholders.
- corporate income is taxed at 25%, an investor with a 45% marginal tax rate will receive a credit for the 25% tax rate paid by the company. The investor will pay 20% based on the difference between the two tax rates.
What is split rate dividend and formula?
dividends distributed from Corporate earnings are taxed at a lower rate than using retained earnings for dividends
Corporate tax rate from earnings distributed + (1-corporate tax rate from earnings distributed)(individual tax rate)
Do shareholders prefer dividend or capital gains?
- investor prefer dividend if tax rate is lower than tax rate on capital gains
- investors still may prefer low dividend rates because they can time the capital gains taxes by choosing when to sell
What are the 2 types of dividend payout policies?
- stable dividend policy: provide shareholders with stable dividend that slowly increases overtime
- constant dividend payout ratio policy: constant percentage of current earnings used to calculate dividends
What is the formula for stable dividend policy, and what is the goal of the formula?
- goal of formula is to gradually adjusts dividends to a target payout ratio
expected dividend = (previous dividend) + [(expected earnings) * (target payout ratio) - (previous dividend)] * (adjustment factor)
Adjustment factor = 1/how many years to implement dividend
What is main benefit of share repurchases?
- Companies reduce the number of outstanding shares, which can increase the value of the remaining share
What are the 4 repurchase methods? BBDR
- Buy in the open market
- Buy back a fixed number of shares at a fixed price
- Dutch auction: rather than offering a fixed price, the company specifies a range for the price it is willing to pay to repurchase its shares
- Repurchase by direct negotiation: Companies may negotiate a repurchase price directly with major shareholders
What is greenmail?
- a corporate strategy that involves buying shares in a company to force the company to repurchase them at a higher price
How does earnings yield lower, equal, or higher than the after tax cost of funds affect EPS?
-If the earnings yield is lower than the after-tax cost of the funds, the EPS will decrease.
-If the earnings yield is equal to the after-tax cost of the funds, the EPS will remain unchanged.
-If the earnings yield is greater than the after-tax cost of the funds, the EPS will increase.
What is formula for earnings yield and after tax cost of borrowing?
Earnings yield = EPS /price per share
After tax cost of borrowing = cost of borrowing * (1 -tax rate)
How does market price per share greater than its book value per share with the affect of a stock repurchase affect the book value per share?
market price per share > book value per share (stock repurchase will decrease the book value per share)
Market price per share <book value per share (stock repurchase will increase the book value per share)
What happens to wealth if company purchases shares at a premium in stock repurchases?
premium: purchase at higher rate than it’s worth
-shares are repurchased at a premium, wealth will be transferred from existing shareholders to the seller (shareholders whose shares are repurchased benefit, while remaining shareholders suffer a decrease in their wealth.)
What are 7 reasons for share repurchases?
- Potential tax advantages
- Share price support/signaling (signal health)
- Financial flexibility
- Offsetting dilution from employee stock options (eg. company choose to repurchase shares to offset the shares created from the exercise of management options.)
- Adjusting capital structure (repurchasing can increase leverage)
- Increases EPS
- company thinks that its shares are undervalued.
What is formula for dividend payout ratio and dividend coverage ratio?
- dividend payout ratio (dividends/net income)
tend to target 40%-60% payout ratio - dividend coverage ratio (net income/dividends)
40%-60% dividend payout ratio = 1.67-2.5 coverage ratio (anything below 1 company dividend may be cut)
What is FCFE coverage ratio, formula, and what does an FCFE coverage ratio of more than 1 mean, 1, and less than 1 mean?
FCFE Coverage ratio = FCFE / (dividends+share repurchases)
- Equal 1 mean the company is distributing all available cash to shareholders.
-greater than 1means company is keeping some earnings to enhance liquidity. - less than 1 means company is borrowing cash to pay dividends, thereby decreasing liquidity.
