lecture 9: dividends and dividend policy

Question 1

the primary generated source of long term funds for a firm

Answer 1

retained earnings

Question 2

what can happened with earnings after all obligations and taxes

Answer 2

retained

paid out as dividends

both

Question 3

dividend policy

Answer 3

determines the split of earnings between cash dividend payments and retained earnings for future reinvestment in capital projects

Question 4

how much to pay as dividends depends on what?

Answer 4

on the investment opportunities of the firm in equation at any given time

Question 5

factors affecting dividend policies (affecting the payout ratio)

Answer 5

legal rules

liquidity position

obligation to repay debt

restriction on debt covenants

availabilities of investment opportunities

earning stabilities

easiness to access capital markets

tax positions of shareholders (dividend tax credit vs capital gains)

Question 6

why are dividend payouts more stable than earnings?

Answer 6

because suspension or reduction in dividends is normally viewed negatively

–> share prices take L

Question 7

benefits of stable dividend policy on stock prices

Answer 7

less risk to shareholders

shareholders can actually live on dividends

shares with stable dividends usually favored by fund managers and conservative individuals

Question 8

most common dividend practice

Answer 8

stable amount per share

Question 9

why is the residual theory of dividends approach theoretically correct?

what must be done to achieve this

Answer 9

assumes firm will invest to the point where MROI or IRR = MCC

MROI: marginal return on investment

MCC: Marginal cost of capital

to achieve this, Optimal dollars must be invested (check graph)

Question 10

why does retained earnings cost less than new common equity?

Answer 10

because of flotation costs

.–> we must used all retained earnings before issuing new shares

Question 11

companies with high growth usually have high or Lowe payouts?

Answer 11

low payouts

Question 12

companies with steady growth usually have high or low payouts?

Answer 12

high payouts

Question 13

what does usually happens to stock prices with an unexpected rise in dividends ?

Answer 13

stock prices rise

Question 14

what does usually happens to stock prices with an unexpected fall in dividends ?

Answer 14

stock prices fall

Question 15

declaration date (date A)

Answer 15

BOD announce on date A dividends that will be paid at date to investors at date C if they hold the stock at date B

Question 16

ex dividend date (date B)

Answer 16

whoever buys the share before the date gets a dividend

whoever sells after date B and before date C gets a dividend

Question 17

holder to record date

Answer 17

when the company makes new book on who the new shareholders are at this date

Question 18

payment date (date C)

Answer 18

payments to shareholders are made

the share price drops approximately by the amount of the dividend paid

Question 19

stock split

Answer 19

giving more shares but at a reduced value so that the additional stocks and the old ones combined equal the value of just the old ones prior to the price reduction

usually to incite others with less capital to invest

Question 20

stock dividend

Answer 20

instead of giving dividend, they offer more shares of equal value that would equate the dividends

Question 21

reverse split

Answer 21

combining a bunch of shares into one for an equal value

Question 22

share repurchases

Answer 22

companies repurchasing their won shares in the open market