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CFDM > Dividend Policy > Flashcards

Dividend Policy Flashcards

1
Q

What are the two types of dividends a company can pay out?

A
  1. Regular dividends
  2. Special dividends
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2
Q

What are the different measures of dividends?

A
  1. Dividend per share (DPS)
  2. Dividend yield
  3. Dividend payout ratio
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3
Q

How do you calculate DPS?

A

DPS = dividend amount / no. of shares

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4
Q

How do you calculate Dividend Yield?

A

Dividend yield = DPS / share price; Or
DY = dividend amount / market value

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5
Q

How do you calculate the Dividend Payout Ratio?

A

Dividend Payout Ratio = DPS / EPS; Or
DPR = dividend amount / earnings

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6
Q

What is the process of a Dividend Payment?

A
  1. Announcement date
  2. Cum-dividend date - last day when shares are traded with dividend right
  3. Ex-dividend date - first day shares are traded without the dividend right
  4. Record date - shareholders are recorded to receive the dividend
  5. Payment date
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7
Q

What are the cash flows associated with selling shares on the Cum-Dividend Date?

A

CF = Pcum - (Pcum - P)•Tcg
where Pcum = share price on cum-dividend date
P = share price when stock was bought
Tcg = tax on capital gains

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8
Q

What are the cash flows associated with selling shares on the Ex-Dividend Date?

A

CF = Pex - (Pex - P)•Tcg + Div(1-Td)
where Pex = share price on Ex-Dividend date
P = share price when stock was bought
Tcg = tax on capital gains
Td = tax on dividends
Div = dividend amount

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9
Q

What is the relationship between the tax rates and Dividend Drop-off on the Ex-Dividend Date?

A
  1. If Td = Tcg, drop-off = dividend, therefore investors are indifferent
  2. If Td>Tcg, drop-off < dividend, therefore investors sell on Ex-Div day
  3. If Td<Tcg, drop-off > dividend,
    therefore investors sell on Cum-Div day
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10
Q

What is M-M’s Irrelevance Theorem?

A

In perfect capital markets, the value of a firm is independent of its payout policy (i.e. investors who want dividends can sell their holdings and investors who don’t want dividends can reinvest them)

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11
Q

Why is Dividend Policy actually relevant?

A
  1. Capital gains are less certain than dividends
  2. Higher dividends require more IPOs and hence higher costs
  3. Information asymmetry - paying dividends implies good cash flow
  4. Agency costs - high payout implies efficient management
  5. Taxes between dividends and capital gains differ
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12
Q

How do you calculate the Net Return of a dividend in a Classical Tax System?

A
  1. Company Level: Dividend payment = (Taxable income - Company Tax)•Dividend Payout Ratio
  2. Investor Level: Net Return = Dividend payment - Personal Tax
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13
Q

How do you calculate the Net Return of a dividend in an Imputation Tax System?

A
  1. Company level: Dividend payment = (Taxable income - Company Tax)•Dividend Payout Ratio
  2. Investor level: Net Return = Taxable Income•Dividend Payout Ratio - Personal Tax
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14
Q

What are the capital gains tax benefits of holding stocks for over one year?

A

Maximum an individual’s capital gains tax can be is 50% of their personal marginal tax rate (i.e. if Tp = 30% maximum Tcg = 15%)

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15
Q

What will shareholders prefer to receive if their personal marginal tax rate is greater than the capital gains tax?

A

Shareholders receive tax returns on dividends but pay tax on capital gains, therefore they will prefer dividends.

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16
Q

What will shareholders prefer to receive if their personal marginal tax rate is less than the capital gains tax?

A

Shareholders with low tax rates may prefer dividends as capital gains are double taxed. Shareholders may prefer capital gains if they can defer realisation until their tax rate drops or they can take advantage of the 1 year discount.

17
Q

What are the issues of having high payout rates?

A
  1. Can lead to fluctuating demand (solution - announce “special dividend”)
  2. May result in firm running short of cash (solution - DRP allow high dividend payouts without losing cash)
18
Q

What are the different types of Off-Market Share Buybacks?

A
  1. Equal access buyback - repurchase from all shareholders
  2. Selective buyback - repurchase from specific limited number of shareholders (requires 75% approval)
19
Q

What is an On-Market Share Buyback?

A

Company repurchase their shares through normal stock exchange trading

20
Q

What are the tax treatments of Off-Market and On-Market Share Buybacks?

A
  1. On-market buy backs are subject to only capital gains tax
  2. Off-market buybacks divide the buyback price into a capital gain and dividend component which are subject to capital gains tax and franking credits respectively.
21
Q

How do you calculate an investor’s After-Tax Proceeds in an Off-Market Share Buyback?

A

After-Tax Proceeds equal the sum of:
1. After-Tax Proceeds from Dividend = Cash dividend - Tax on grossed up dividend + franking credits
2. After-Tax Proceeds from Capital Component with CGT Benefits = Capital component - personal tax•0.5•capital gain/loss; OR
3. After-Tax Proceeds from Capital Component without CGT Benefits = Capital Component - personal tax•capital gain/loss

22
Q

How do you calculate an investor’s After-Tax Proceeds of the capital component in an Off-Market Share Buyback under TD 2004/22?

A
  1. Deemed consideration = 5-Day VWAP•(1 + market change)
  2. Capital component = Deemed consideration - dividend
  3. Capital gain/loss = price of bought shares - capital component
  4. After-Tax Proceeds = Capital component without 5-Day VWAP + personal tax•CGT Benefit•capital gain/loss
23
Q

What are the reasons for a Share Buyback?

A
  1. Improved performance measures - EPS increases as shares are bought back
  2. Signalling - managers buying back stock shows that stock is undervalued
  3. Financial flexibility - dividends are long term commitments as they create expectations from market and buyback prices, periods, etc. can change
  4. Employee share options - employees with shares won’t experience a price drop from a buyback
24
Q

Which types of firms payout dividends?

A

Firms with higher permanent operating cash flows - dividends increase with good performance

25
Q

Which types of firms use Share Buybacks?

A

Firms with temporary non-operating cash flows that are more volatile - poor stock market performance leads to firms repurchasing stock

26
Q

What are Off- and On-Market Share Buybacks used for?

A
  1. Managers favour off-market share buybacks to distribute franking credits when the buyback is larger, and the firm is generating more cash flows
  2. On-market share buybacks are more likely to be used when the firm is undervalued

CFDM (4 decks)

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