Dividends

Question 1

What are the basic types of cash dividends?

Answer 1

1. Regular cash dividends
2. Extra dividends
3. Special dividends.
4. Liquidating dividends

Question 2

What is a cash dividend?

Answer 2

Regular cash dividends are most common and often paid twice a year.

Question 3

What is an extra cash dividend?

Answer 3

Occasionally the firm will pay an additional dividend it is considered as “extra” and may or may not be repeated in the future.

Question 4

What is the difference between an extra cash dividend and a special dividend?

Answer 4

They are similar, however special suggests that it is unusual or one-off and unlikely to be repeated. i.e. Centenary dividend and is usually paid together with normal dividends

Question 5

What is a liquidating dividend?

Answer 5

A dividend that is a result from selling off assets (paid in capital may be reduced). As opposed to a normal dividends where it is paid from corporate cash or retained earnings.

Question 6

What is the difference between dividends per share, dividend yield and dividend payout?

Answer 6

1. Dividends per share is $dividend/share price
2. Dividend yield = %dividend/ share price
3. Dividend payout = Dividends Paid/ Net Income

Question 7

What is the chronology of a dividend payment?

Answer 7

1. Declaration date (board of directors passed resolution to pay dividend)
2. Ex-dividend date. Two business days before date of record. Anyone who purchases during this period will not have the benfit of a dividend therefore the price is usually price - dividend
3. Date of record. List is of entitled holders prepared and recorded.
4. Date of payment. When amounts are paid.

Question 8

What happens to the price of a share when it goes ex-dividend?

Answer 8

It usually drops about the same rate as the dividend as the holder who purchases will not be entitled to a dividend. But depending on their tax position, franked dividends may result in not the full amount being decreased.

Question 9

What is the net effect of time value when dividends are paid?

Answer 9

It does not matter.

If a firm is due to pay 150000 in year 1 and 2 (300k total). It makes no difference.

Suppose share holders are unhappy and want 200k paid on the first year due to the time value of money.

The firm can sell additional shares (or borrow more debt) of $50k. To add onto the $150k payment = $200k to shareholders in year 1. In year 2 with $100k remaining, the shareholders who purchased $50k worth of shares at 10% rate will expect their dividends of $5k. If we then take that away from $100k remaining for year 2 for the existing shareholders it is $95k

If we then calculate the time value of money $200k in year 1, and $95k in year 2. It is equivalent to $150k in year 1 and $150k in year 2.

Question 10

How could a shareholder who is dissatisfied with the firm’s dividend structure “home-made” dividends? (150k year 1 and 2 example)

Answer 10

1. If someone prefers $200k year 1 and $95k year 2 then they can sell $50k of shares in year 1 and will only be left with $95k in year 2. Because he is technically losing $50k+ the 10% dividend her would have received in date 2 if he kept the additional shares)
2. If someone prefers $150k year 1 and 2. They can reinvest $50k of the extra/uneeded funds into more shares, therefore by year 2 she will received an additonnal $50k+5k (interest) added to the $95k on the existing shares her cash flow is equal to $150k year 1 and 2.

Question 11

Is Dividend Policy is irrelevant?

Answer 11

True

Question 12

Are dividends irrelevant?

Answer 12

False

Question 13

Why would low dividend payouts be preferred?

Answer 13

1. Tax: Due to tax laws that might make it more beneficial to have capital gains.
2. Imputation system: Designed to remove problem of double taxation for resident individual taxpayers. It gives the individual credit (imputation) for the tax already paid by the company in a franked dividend.

Question 14

What is the imputation system and how does it work?

Answer 14

Imputation system: Designed to remove problem of double taxation for resident individual taxpayers. It gives the individual credit (imputation) for the tax already paid by the company in a franked dividend.

A person who receives a dividend of $70 ($100 value however company has paid $30 as corporate tax). If their earnings including their earning of $100 value of dividend are in the lower tax bracket of 20%. They are entitled to the 10% i.e. $10 of tax credit that the company has already paid for. Inversely if the person is a high income earning and is required to pay a tax rate of 40% then they would owe taxes an additional $10. However if there are discounts for capital gains and can be differed, investors may choose to continue receiving dividends.

Question 15

How do you gross up the dividend received?

Answer 15

D / (1-Tc) = Dividend Value, D = Dividend received

Question 16

How to calculate final cash flow based on dividends and tax?

Answer 16

Company tax paid - (Personal Tax rate * Full dividend value) + Dividend paid = Final cash flow

i.e. 1 share holder. EBIT = $1000. Tc = 30%. So tax = $300. Dividend paid of $700.

Share holder has tax rate of 35%
$300 - (35% x $1000) + $700 = $675

Question 17

Who benefits more from choosing franked dividends vs capital gains?

Answer 17

Lower-income earners as their tax rate is lower and they can take advantage of the tax credits. The difference for high-income earners is negligible.

Question 18

Why is it costly to issue new shares? Two identical firms compared issuing new shares vs ploughing back to reinvest?

Answer 18

Because of the cost of flotation. If two firms are identical it is more likely that the equity of the firm who reinvests increase. While the one with the higher payout ratio selling new shares will have to continue doing so to make up for the flotation costs. So therefore some firms may choose to have low or no payout at all.

Question 19

Does a cash dividend have less impact than a home-made dividend for high or low-income earners?

Answer 19

High

Question 20

What are real world factors favouring a high payout?

Answer 20

1. Desire for current income: as sale of low dividend shares would involve brokerage fees, transactional costs. Psychological fear of using the principle amount.
2. Uncertainty resolution: Dividends in the future may be affected by a number of factors, so “bird in hand” is worth more. But the investor can just sell share at any time. The real question should be between current dividend VS current capital gain, NOT current dividend vs future dividend.
3. Tax and Legal benefits: i.e corporate investors prefer high dividend yields as it is tax neutral compared to capital gains. Some institutions such as superannuation funds so therefore can take advantaged of already franked credits. Legal reasons include due to fiduciary responsiblity to invest in companies with established dividend records. Some institutions are also prohibited from spending principal (trust funds). Whereas superannuation funds who will have to meet large retiree payouts would require low current dividend and large cpital gains to meet future commitments.

Question 21

What is the information content effect of dividends?

Answer 21

Companies only cut dividends with reluctance and only tend to raise dividends if they are confident of future projections therefore when companies increase dividends it is a sign of confidence and therefore the price increases. Not because the firm changes the ratio of funds to be paid via dividends.

Question 22

What is the clientele effect?

Answer 22

that stocks attract particular groups of investors i.e. if 40% of the market wants high yielding dividends and there was a shortage of options a company that has low yielding dividends would benefit from changing their strategy, at least until this percentage is available for the investors (supply/demand)

Question 23

Would you expect a risky firm with significant but highly uncertain growth prospects to have a low or high dividend payout?

Answer 23

Low as the future is uncertain. If they have high dividend payout it could mean they will be in a position to sell more shares and lose funds due to flotation and other admin costs.

Question 24

What is the residual dividend approach?

Answer 24

policy where a firm pays dividends only after meeting its investment needs while maintaining a debt to equity ratio. i.e. get current ratio of firm then work out how much equity and debt firm is made out of from firm value. compare equity of that against earnings (do not split earnings into a ratio)

Question 25

Cash Dividend Vs repurchase? What stays the same what changes if all else is the same?

Answer 25

Cash Dividend - Shares Price reduce, EPS same, P/E reduces, Balance sheet reduces (but same as Repurchase)
Repurchase - Share Price same, EPS increase, P/E reduces (same as Dividend), Balance sheet reduces (but same as Dividend)

Question 26

What are the consequences of a share buyback on a company’s EPS?

Answer 26

EPS goes up because the same earnings are divided between less shares.

Question 27

What is a bonus share issue or share split?

Answer 27

It increase the number of shares, does not change owners equity just that each share will be worth less. No change to Paid up capital (only increase or decrease in shares outstanding) Capital reserve and retained earnings or total shareholders funds.

Question 28

What is a trading range?

Answer 28

Price range between highest and lowest prices at which stock is traded.

Question 29

Why would someone do a reverse split if it makes no difference to value?

Answer 29

1. Marketability of shares might be improved when its priced is raiased to the popular trading range.
2. Shares selling below a certain level may not be considered respectable. i.e. investers underestimate firms earnings cash flow or growth.
3. May also bring it up to a minimum to be traded on ASX for example.
4. Transaction costs may be less after reverse split.