chapter 15 Flashcards
What is FCF
all cash flows available for distribution
how should a company use its FCF
pay interest
pay debt principal
pay dividends
repurchase stock
buy non operating assets
what is the declaration date for dividend payments
the which a firms directors issues a statement declaring dividends
what is the holder-of-record date in terms of dividend payment
at the close of business on holder-of-record date the company closes up stock transfer books and makes up a list of shareholders as of that date
what is the ex-dividend date
the date when the right to the dividend leaves the stock
usually, a day before the holder-of-record date
what is the payment date
date which firm actually sends dividend checks
what are stock repurchases
when a company buys back some of its own outstanding stock
what are the three ways in which stock repurchases are made?
- firm can buy back through open market
- firm can make an offer to current holders of stock
- targeted stock repurchase: firm can buy a block of shares from one large holder
target distribution ratio
the % of NI distributed to shareholders through cash dividends or stock repurchases
target payout ratio
% of NI paid as a cash dividend
what does it mean if a firm has a high distribution ration and high payout ratio
the dividend yield is relatively high and the expected capital gain is low
what does it mean if a firm has a large distribution ratio and a low payout ratio
a low dividend yield but a relatively high expected capital gain yield
what does it mean if a firm has a low distribution and payout ratio
low dividend yield and it is hoped that they have a high capital gain
what is the dividend irrelevence theory
the value of a firm depends only on income produced by its assets not on how this income is split between dividends and R.E
what is an important assumption to the dividend irrelevance theory
no taxes or costs exist (makes the two ways more equal if you ignore costs)
Dividend Preference (Bird-in-the-Hand) Theory
Myron Gordon and John Litner:
a stock risk declines as dividends increase
stockholders prefer dividends and are willing to accept a lower return on stock
What is Capital Gain Preference
stock price appreciation is still taxed more favorably than dividend income
- increase in a stocks price isn’t taxable until the stock is sold, whereas dividend is taxed immediately
investors should be willing to pay more for a low payout company
Myron Gordon and John Litner believe that the required return on equity increases as the dividend payout ratio is decreased. Their argument is based on the assumption that….
investors view dividends as less risky than potential future capital gains
What is the clientele Effect? and give examples
different groups of investors have different payout policies
retired, low income, or need cash now: dividend preference
stockholders in peak years: prefer capital gains
why should managers be hesitant to change their dividend policy
clientele effect
What should be in a company’s mind when deciding how much cash to distribute to stockholders
- ## how they can maximize shareholders value
when firm’s product a lot of cash but distribute a lot to shareholders what clientele does this attract?
clientele that prefer high dividends
when firms generate little or no excess cash because they have so many good investment opportunities meaning they don’t distribute cash but do enjoy rising earnings and stock prices, who does this attract?
investors who prefer capital gains
what are the four steps to determining a target distribution ratio?
- determine optimal capital budget
- determine amount of equity needed to finance budget
- use reinvested earning to meet equity requirements
- pay dividends or repurchase stock only if more earnings are available than needed to support the optimal capital budget
what does rigidly following the residual policy lead to?
fluctuating and unstable dividends
how should firms use the residual policy
as a guide to set up their long-run target distribution ratios NOT as a guide to the distributions in a singular year
what is the low-regular-dividend-plus-extras policy
when a company announces a low regular dividend that it is sure can be maintained and then if extra funds are available the company pays a extra dividend or repurchases stock
What are the advantages of repurchases
- viewed as a positive signal to investors
- stock holders have a choice when the firm distributes cash by repurchasing stock
- dividends are “sticky” in the short run and repurchases are a good short-term
- residual model: target cash distribution levels
- large scale changes in capital structures
- companies can grant stock options
what are disadvantages of repurchases
- cash dividends are dependable
- the selling stockholders may not be fully aware of all the implications of a repurchase
- corp may pay too much for repurchased stock
what are other factors that influence distributions
- the cost of selling new stock
- ability to substitute debt for equity
- control (manager may not want to lose control)
what is a stock split
when you double the number of shares outstanding and cut the price
when are stock splits normally used?
when there is a sharp price run up
what are stock dividend
current share holders receive additional shares
- usually on a regular annual basis
what is a dividend reinvestment plan
a plan that allows stockholders to automatically purchase shares of common stock with their cash dividends
what are the two types of dividend investment plans
- one with stock that is already outstanding
- one involves newly issued stock
