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MOS 1023 Chapter 11 > Chapter 11.1 > Flashcards

Chapter 11.1 Flashcards

Dividends

1
Q

What are the very important financing decisions that have implications for a firm’s future investment and capital structure policies?

A

Decisions concerning:
- Whether to distribute value to stockholders
- How much to distribute
- How best to distribute it

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2
Q

Any time value is distributed to a firm’s stockholders what amount in the firm is reduced?

A

The amount of equity capital invested in the firm

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3
Q

What is the impact of stockholder distributions if a firm doesn’t raise additional equity by selling new shares?

A

Distributions to stockholders reduce the availability of capital for new investments and increase the firm’s financial leverage

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4
Q

What can distributions to stockholders involve?

A

Distribution of cash, assets, or something else, such as discounts on the firm’s products that are available only to stockholders

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5
Q

When a firm distributes value through a dividend, what does it reduce?

A

The value of the stockholders’ claims against the firm

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6
Q

Consider firm that has: $1000 cash + other assets w/ market value of $9000

If firm has no debt and 10,000 shares are outstanding, what is the value of each share?

A

Each share of this firm is worth $1, since the total value of the cash and the other assets is $10,000 and the stockholders own it all

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7
Q

Consider firm that has: $1000 cash + other assets w/ market value of $9000

If firm has no debt and 10,000 shares are outstanding, but management now distributes the $1,000 of cash as a dividend, how much does each stockholder receive? How much does the value of each share decline?

A

10 cents ($1,000/10,000 shares = $0.10) for each share that they own

Value declines to 90 cents

Firm now worth $9,000 and there are still 10,000 shares

Each stockholder still has $1 of value for each share owned, but the share represents only 90 cents of the total (the other 10 cents is in hands of the stockholder, who can spend or reinvest it)

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8
Q

How does a dividend reduce the stockholder’s investment in a firm?

A

By distributing some of that investment to them. The value that they receive through dividend was already theirs. Dividend simply takes this value out of the firm and returns it to them.

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9
Q

T or F: dividends only take one form

A

False: they can take various forms

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10
Q

What is the most common form for dividends?

A

Regular cash dividend

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11
Q

What is the regular cash dividend?

A

A cash dividend that is paid regularly, typically quarterly and is a common means by which firms return some of their profits to stocholders

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12
Q

What is a common way by which firms return some of their profits to stockholder?

A

By regular cash dividend

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13
Q

By one estimate, how many U.S. firms paid cash dividends during the year 2000?

A

1,850

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14
Q

The dividend payments made by a vast majority of U.S. firms during the year 2000 were part of what programs?

A

Part of regular cash dividend payment programs

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15
Q

What is an example of a company paying a regular cash dividend?

A

In 2017 Hilton was paying a regular cash dividend of $0.15 each quarter

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16
Q

What is the size of a firm’s regular cash dividend typically set at?

A

A level that management expects the company to be able to maintain in the long run

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17
Q

Why is the size of a firm’s regular cash dividend typically set at a lvl management expects company to be able to maintain in long run?

A

Because barring some major change in the fortunes of the company, management doesn’t want to have to reduce the dividend

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18
Q

How are dividend reductions often viewed by stock market investors?

A

View them negatively

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19
Q

Why can management afford to err on the side of setting the regular cash dividend too low?

A

Because it always has the option of paying an extra dividend if earnings are higher then expected

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20
Q

What is an extra dividend?

A

A dividend that’s generally paid at the same time as a regular cash dividend to distribute additional value

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21
Q

When are extra dividends often paid, and why do companies use them to distribute to stockholders?

A

Often paid at the same time as regular cash dividends, some companies use them to ensure that a minimum portion of earnings is distributed to stockholders each year

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22
Q

Suppose that the management of a company wants to distribute 40 percent of the company’s net income to stockholders each year. If the company earns $2 per share in a particular year and the regular cash dividend is 60 cents per share, how much of an extra dividend can be paid at the end of of year to hit its 40% payout target?

A

Extra 20-cent dividend ( 0.4x$2 - $0.60)

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23
Q

What is a special dividend?

A

A one-time payment to stockholders that’s normally used to distribute a large amount of value

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24
Q

How is a special dividend similar to an extra dividend?

A

It’s a one-time payment to stockholders

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25
How are special dividends different from an extra dividend?
Tend to be considerably larger than extra dividends
26
What are special dividends normally used to distribute?
Unusually large amounts of cash
27
Whats an example of a situation where a company might use a special dividend?
To distribute excess cash from operations that has accumulated over time
28
Give an example of a company paying a special dividend.
Microsoft in 2004 when it paid a $32.4 billion special dividend
29
Aside from distributing excess cash from operations that's accumulated, what might a special dividend also be used to distribute?
The proceeds from the sale of a major asset or business or as a means of altering a company's capital structure
30
What is the Sealed Air Corporation?
The company that first produced plastic sheets of packaging materials with air bubbles
31
How is the Sealed Air Corporation a good example of how a special dividend can be used to dramatically change a company's capital structure?
In April 1989, Sealed Air borrowed $306.7 million, which it combined with cash it already had on hand to pay a $40/share ($329.8 million) dividend. Since price of Sealed Air's stock was only about $45 before the dividend, most of the equity was distributed to stockholders.
32
What was the net effect of borrowing money to pay a large dividend in the case of the Sealed Air Corporation?
To substantially increase the debt-to-total-capital ratio: from 8.1% to more than 76.2% The senior management increased the company's leverage so dramatically in order to provide managers at all lvls w/ incentives to focus on maximizing the firm's cash flows
33
What is a liquidating dividend?
The final dividend that's paid to stockholders when a firm is liquidated
34
What does it mean to say that a "firm is liquidated"?
Its assets are sold; the proceeds from the sale of the assets are distributed to creditors, stockholders, and others who have a claim on the firm's assets; and the firm ceases to exist
35
In the US, what are the proceeds from the sale of a company's assets first used to pay (in a liquidation)?
All wages owed to the employees and the company's obligations to suppliers, lenders, the various taxing authorities, and any other party that has a claim on those assets
36
When can the company start to pay a liquidating dividend to the stockholders? What must be done first?
All obligations must be satisfied, only then can they pay a liquidating dividend to stockholders
37
what do the priorities to pay off all obligations in a liquidating dividend highlight?
The fact that the stockholders are truly the residual claimants to a firm's assets
38
What can distributions of value to stockholders also take the form of?
Discounts on the company's products, free samples, and the like
39
Why are non-cash distributions often not thought of as dividends?
- Value received by stockholders isn't in the form of cash - Value received by individual stockholders doesn't often reflect their proportional ownership in the firm
40
What unique benefit did CSX Corporation offer its stockholders in the place of cash dividends for their Greenbrier resort?
CSX stockholders received a discount on the cost of their hotel room when they stayed at Greenbrier
41
How did the value of the Greenbrier discount compare to cash dividends for a small stockholder (around 200 shares)?
For a 3-4 day stay, this discount could easily equal the value of the regular cash dividend for someone who owned 200 shares
42
Was the discount given by CSX stockholders for their Greenbrier resort in the place of cash dividends more beneficial to large or small stockholderholders? Why?
More beneficial to small shareholders, bc the value of the discount was exactly the same for someone who owned 1 million shares. For large stockholder, the value of the discount would be small compared w/ the value of the cash dividend The discount could actually exceed the total value of the shares owned by a stockholder who only had 5 or 10 shares
43
What were the discounts offered to CSX stockholders an example of and why?
True distributions of noncash value because the resort could rent the discounted rooms at full price, there was a very real opportunity cost associated with these discounts
44
What takes place before a dividend is payed?
A relatively standard sequence of events
45
How does the process before a dividend is payed differ between publicly traded and private companies?
The process is more easily defined for companies with publicly traded stock than for private companies
46
What is the timeline for the sequence of events in the dividend payment process at a public company?
1. Board vote 2. Public announcement (declaration date) 3. Ex-dividend date 4. Record date 5. Payable date
47
When does the dividend payment process begin?
When the board votes to pay a dividend
48
What happens in the dividend payment process shortly after the board votes to pay a dividend?
The firm publicly announces its intent to pay a dividend (declaration date)
49
What else does a firm announce when publicly announcing its intent to pay a dividend?
- The amount of the dividend - The ex-dividend date - The record date
50
What is the record date?
The date by which an investor must be a stockholder of record in order to receive the dividend
51
What is the ex-dividend date and who is it set by?
Set by the stock exchange: normally precedes the record date by 2 days and is the date before which an investor must buy the stock to be a stockholder of record on the record date
52
Normally, how many days does the ex-dividend date precede the record date?
By 2 days
53
What is the payable date?
The date on which the firm actually pays the dividend
54
Who votes to pay a dividend?
Dividend payment process begins with vote by company's board of directors
55
As stockholder representatives, what must the board approrve?
Any distribution of value to stockholders
56
What is the date on which the announcement made known as?
The declaration date or announcement date of the dividend
57
What is the declaration date?
The date on which a dividend is publicly announced
58
What does the announcement (of a dividend) typically include?
The amount of value that stockholders will receive for each share of stock that they own, as well as the other dates associated with the dividend payment process
59
What often happens to a firm's stock when a dividend is announced?
The price of a firm's stock often changes
60
Why does the price of a firm's stock often change when a dividend is announced?
Because the public announcement sends a signal to the market about what management thinks the future performance of the firm will be
61
What happens to the price of a firm's stock if the signal to the market differs from what investors expected?
They will adjust the prices at which they're willing to buy or sell the company's stock accordingly
62
What can the announcement that a company will pay an unexpectedly large dividend indicate about what management thinks future profits will be? What may happen to the stock price?
Management is optimistic about future profits: suggests that future cash flows are higher than expected Can result in an increase in the company's stock price
63
What can the decision to cut/eliminate a dividend indicate about what management thinks future profits will be? What may happen to the stock price?
Management is pessimistic and can cause stock price can go down
64
What is the important relationship between dividend decision information and stock prices?
Dividend decision sends info to investors and that info is incorporated into stock prices at the time of public announcement
65
What kind of info does a dividend announcement reveal about management?
Management's view of a company's prospects
66
What will investors use dividend announcement to do?
To refine their expectations concerning future cash flows from the company
67
What does a change in investor expectations cause in the company's stock price?
To change at the time of public announcement
68
Why is the ex-dividend date important and when is it announced?
Included in the public announcement it's the firm date on which the stock will trade without rights to the dividend
69
What is the ex-dividend date?
The first day on which a stock trades without the rights to a dividend
70
When must a investor buy shares before to receive the dividend?
Before the ex-dividend date
71
What happens if an investor buys stock ON or AFTER the ex-dividend date?
They will not receive the dividend
72
Before the ex-dividend date, a stock is said to be trading _______ or ______ dividend
Cum dividend, or with dividend
73
On or after the ex-dividend date the stock is said to trade _______
Ex dividend
74
Why is it important for investors to know the ex-dividend date?
Because it can have significant implications for the taxes and transaction costs they pay
75
In the context of taxes, what will happen if an investor purchases the company's shares before the ex-dividend date?
The investor knows that they will soon receive a dividend on which taxes will have to be paid
76
Who are dividends received by investors taxed by, and what types of investors are exempt from the taxes?
Taxed by state and federal governments unless investor is a tax-exempt organization such as a university endowment
77
How can a dividend create difficulties for a stockholder who wants to have a specific amount of money invested in the firm?
By returning value to the stockholder, a firm that pays a dividend may reduce the stockholder's investment below the level preferred by the stockolder
78
What may a stockholder have to do if a dividend bring's the stockholder's investment below the level preferred by the stockholder?
Makes it necessary for the stockholder to purchase additional shares and incur the associated brokerage fees and possibly other transaction costs
79
Can the price of the firm's shares change on the ex-dividend date?
Yes, even if there's no new info about the firm
80
Why can the price of a firm's shares drop on the ex-dividend date even if there's no new info about the firm?
Drop simply reflects difference in the value of the cash flows that the stockholders are entitled to receive before and after the ex-dividend date
81
Consider a company that recently announced a $1 per share dividend. The company's stock is currently trading for $10 per share, and the ex-dividend date is tomorrow. In this example, why does the $10 price includes the value of the dividend?
Because an investor who purchases this company's stock before the ex-dividend day will receive the dividend You can think of the $10 as consisting of a $1 dividend plus the value of the stock on the ex-dividend date Since an investor who buys the stock tomorrow will receive only the stock, and not the dividend, the price of the stock will certainly be below $10 tomorrow
82
Do stock prices usually drop by exactly the amount of the dividend on the ex-dividend date?
No. Research has shown that stock prices drop on ex-dividend date, but the drop is smaller than the full amount of the dividend
83
Why do stock prices usually not drop by the full amount of the dividend on the ex-dividend date?
Because the dividend will be taxes. If you knew that you would have to pay 23.8% on a dividend that you received, you wouldn't pay 100% of the value of that dividend
84
What became the max tax rate for dividends in 2013?
23.8%
85
What is the after-tax value of a $1 dividend if you have to pay a 23.8% tax on it?
$0.762 [$1.00 × (1 − 0.238) = $0.762]
86
If investors pay a 23.8% tax on dividends, the dividend is $1 and the share is currently trading at $10, what does the stock price drop to on the ex-dividend date?
$9.238= $10 -[$1.00 × (1 − 0.238) = $0.762] This includes $0.762 for the dividend and $9.238 for other cash flows
87
What is the record date?
The date by which an investor must be a stockholder of record in order to receive a dividend
88
How many days after the ex-dividend date does the record date typically follow?
2 business days after the ex-dividend date
89
What must an investor be on the record date in order to receive the dividend?
Stockholder (officially listed as a stockholder) of record
90
What does it mean to be a stockholder of record?
Officially listed as a stockholder
91
When does the board specify the record date?
When it votes to make the dividend payment
92
What does the exchange set once the company informs the exchange on which its stock is traded, what the record date is?
Exchange sets the ex-dividend date
93
Why does the ex-dividend day precedes the record date?
Because it takes time to update the stockholder list when someone purchases shares
94
When must an investor buy shares before so that the exchange will ensure that they're listed as a stockholder of record for that company as of the record date?
Before the ex-dividend date
95
What is the final date in in the dividend payment process?
The payable date
96
What is the payable date?
The date on which a company pays a dividend
97
When do the stockholders of record actually receive the dividend?
On the payable date
98
When is the payable date?
Typically a couple of weeks after the record date
99
What does it mean when a company pays a regular cash dividend quarterly on an approved regular cash dividend of $ per share per year?
After the board vote, stockholders could expect to receive 1/4 of the yearly $/per share/year, each quarter
100
Why is the dividend payment process not as well defined for private companies as it is for public companies?
Because in private companies: - Shares are bought/sold less frequently - Fewer stockholders - No stock exchange involved in the dividend payment process
101
Why is it easy to authorize & inform all stockholders of the decision to pay a dividend for private companies?
Board members know the identities of the stockholders when they vote to authorize a dividend- generally the list of stockholders is relatively short and largest stockholders are on the board
102
Why can the record date and payable date be on any day on or after the day that the board approves the dividend for private companies?
There is no public announcement, and there is no need for an ex-dividend date
103
What's easy about the dividend payment process for private companies?
Easy to inform all stockholders of the decision to pay a dividend and it is easy to actually pay it

MOS 1023 Chapter 11 (5 decks)

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