Dividend Policy (W10)

Question 1

Payout Policy

Answer 1

The way a firm chooses to payout cash to shareholders.

Question 2

Declaration Date

Answer 2

Board declares the dividend, it becomes a liability of the firm

Question 3

Ex-Dividend Date

Answer 3

If you buy stock on or after this date, you will not receive the dividend.

Question 4

Record Date

Answer 4

Holders of record are determined, they will receive the dividend payment.

Question 5

Behaviour of Prices on Ex-Dividend Date

Answer 5

Value of the company falls, in a perfect world stock price will fall by same amount as dividend but in reality it typically falls by less due to taxation on dividend and/or information content

Question 6

Dividend Imputation System

Answer 6

Share price will actually fall by more than the dividend amount due to the value of franking credits.

Question 7

In an imperfect capital market dividend policy either… (2)

Answer 7

still doesn’t matter (as in perfect capital market)
or dividend policy does matter and high payout preferred (investor biases) or low payout preferred (capital gain preferred due to retained earnings funding future capital growth)

Question 8

4 Common Dividend Policies

Answer 8

Residual Dividend Policy
Smoothed Policy
Stable Policy
Low Regular Dividend plus Extra Policy

Question 9

Residual Dividend Policy

Answer 9

Annual dividends will fluctuate based on earnings levels and investment needs

Question 10

Smoothed (Target Payout) Policy (3)

Answer 10

Long-term average residual payout policy
Constant payout policy
Fluctuating dividend amount –> depends on annual changes in net income

Question 11

Stable Policy (3)

Answer 11

Pays a constant and potentially increasing dividend amount each year
Dividends are only increased in response to a long-term increase in expected earnings
Actively avoids lowering dividend payments.

Question 12

M&M Irrelevance Theory on Dividends

Answer 12

Dividend Theory has no effect on firm value - firm value is determined solely by the earning power of the firms assets.

Question 12

Homemade Dividends - If dividends are lower than desired shareholders can…

Answer 12

sell shares to obtain the desired cash

Question 13

Homemade Dividends - If dividends are higher than desired shareholders can…

Answer 13

use funds to buy additional shares –> homemade capital gain.

Question 14

Dividend Imputation System (4)

Answer 14

Introduced late 1980s
Double taxation of retained earnings
Earnings distribution choice of firms is between earnings retention (capital gain) or payment of franked/unfranked dividends
Preference dependant on shareholders’ marginal personal tax rate and shareholder status (general preference for resident investors is payment of franked dividends)

Question 15

How dividend imputation system works (3)

Answer 15

Company pays tax on domestic-sourced income at corporate tax rate
Dividend paid from after-tax net income
Shareholder than subject to personal income tax on “grossed-up” dividend amount and can deduct this from tax payable on the franking credit received.

Question 16

Non-tax reasons for relevance of dividend policy (5)

Answer 16

Dividend Signalling
Dividend Stability
Agency Costs
Share Issue Costs for Firms
Transaction Costs for Investors

Question 17

Effect of Stock Dividends

Answer 17

Stock price will fall because the same total equity value now divided over larger number of shares.

Question 18

Stock Splits (2)

Answer 18

Increase number of shares to boost company liquidity, issuing to investors in a set proportion
Motivation is to keep share price in a range attractive to small investors.

Question 19

What is share repurchase/buy back?

Answer 19

Company can offer to shareholders to buy their shares at a fixed price or market price.

Question 20

Characteristics of Share Repurchase/Buy Back (4)

Answer 20

Shares are removed from the issued capital and retired
Can be financed out of retained earnings or debt
Influences the ownership structure of the firm, capital structure and EPS (potentially share price)
Announcement of share repurchase normally has positive influence of share price

Question 21

Motives for Share Repurchase (5)

Answer 21

Dividend Substitution - means of paying additional dividend to stockholders.
Shareholder preference for dividends vs. capital gains
Improved Performance measures -> improve EPS and increase debt/equity ratio
Financial Flexibility
FCF Hypothesis - reduce agency problem for firms with no positive NPV investment

Question 22

Dividend Payment leads to a fall in the ex-dividend price by dividend amount which

Answer 22

offsets by receiving the dividend.