Topic 9- Dividend and Payout Policy

Question 1

What are the 2 main types of payout policies?

Answer 1

• Dividends

- Stock repurchases

Question 2

What are the 3 main types of dividends?

Answer 2

• Cash dividend
• Stock dividend
• Stock split

Question 3

Describe a cash dividend and its 2 possible forms

Answer 3

Payment of cash by the firm to its shareholders. It can pay regular dividends or on occasion give out special dividends

Question 4

Describe a stock dividend

Answer 4

Distributions of additional shares to a firm’s stockholders

Question 5

Describe stock splits

Answer 5

Issue of additional shares to firm’s stockholders

Question 6

What happens to a firm’s value after dividends are paid?

Answer 6

After dividends are paid, a firm’s value falls- as does it’s stock price as a result. This is because the firm uses it’s assets (cash) to pau dividends so it now has fewer assets

Question 7

What are the 4 ways to implement a stock repurchase?

Answer 7

• Open-market repurchase
• Tender offer
• Dutch auction
• Private negotiation (greenmail)

Question 8

Describe an open-market purchase

Answer 8

Firm purchases stock in the secondary market

Question 9

Describe a tender offer

Answer 9

Firm offers to buy back a stated number of shares on pre-specified terms (amount, price, time)

Question 10

Describe a dutch auction

Answer 10

Firm states a range of prices at which it is prepared to repurchase

Question 11

What happens to a firm’s value after stocks are repurchased?

Answer 11

A firm’s market value falls but its share price doesn’t. This is because although the firm reduces its assets by repurchasing, it also reduces the number of outstanding shares

Question 12

What is the MM dividend irrelevance proposition?

Answer 12

In a perfect capital market, ignoring personal taxes and holding fixed the investment policy of a firm, the firm’s choice of dividend policy is irrelevant to its value

Question 13

What are the 3 main signalling effects of payout policy?

Answer 13

• Dividends and repurchases provide clues about a company’s true financial prospects
• Informational aspects of dividends: dividend increases send good news about future cash flow and earnings
• Share repurchase also good news

Question 14

What is the tax incentive for firms paying low dividends?

Answer 14

Capital gains taxed at lower rate than dividend income

Question 15

What are the 3 steps of the Cash/Trust Nexus?

Answer 15

1. How much did the company actually pay out during the period in question?
2. How much could the company have paid out during the period in question?
3. How much do I trust the management of this company with excess cash?

Question 16

What is Free Cashflow to Equity (FCFE)?

Answer 16

A measure of how much cash is left in the business after non-equity claimholders (debt and preferred stock) have been paid and after any reinvestment needed to sustain the firm’s assets and future growth

Question 17

What are outstanding shares?

Answer 17

Shares issued to and held by investors

Question 18

What are treasury shares?

Answer 18

Shares held by the corporation itself

Question 19

What is the declaration date?

Answer 19

The date on which the board of directors of a firm announce the next dividend payment

Question 20

What is the ex-dividend date?

Answer 20

The date by which an investor must purchase a share to receive a dividend; the day before the record date

Question 21

What is the record date?

Answer 21

The cut-off date used to determine which shareholders of a stock are entitled to a dividend

Question 22

What is the consensus amongst Financial Executives concerning dividend policy?

Answer 22

They primarily try to avoid reducing dividends

Question 23

What is a key assumption of the MM dividend irrelevance argument?

Answer 23

That new shares are sold at a fair price

Question 24

What is a main reason as to why shareholders often insist on higher dividends?

Answer 24

Shareholders may not trust managers to spend retained earnings wisely

Question 25

What are investors’ stock preferences if dividends are taxed more heavily than capital gains?

Answer 25

Investors should be willing to pay more for stocks with low dividend yields