Session 8 Slides Afm Exam Version N

Ch 16: Today’s Agenda
16-1
Chapter 16: Payout policy

• Payout alternatives
• Information in Dividends and Stock Repurchases
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
Payout policy
16-2
Payout policy deals with two questions
1.How much cash should the company pay out to

its shareholders
2.Should the cash be paid out dividends or by
buying back the company’s shares
Payout policy
16-3
Cash dividend vs stock repurchases
Average each year for

US companies (2011-17) Pay dividends?
Yes No
• 15.2% pay both dividends and Repurchase Yes 23.4% 20.6%
repurchase shares No 13.9% 42.1%
• 18.3% pay only dividends
• 11.2% repurchase only shares
• 55.3% don’t payout anything
Dividend & Stock Repurchases
16-4
• Both dividend and share repurchases have risen

significantly in the last 10 years
• Dividends are more stable than share repurchases
U.S. Data 1980-2017
Dividend Payment
16-5
How dividend is paid

Declaration date
• The company declare how much dividend will be paid out
Record date
• Investors registered as shareholders on this date will receive the
dividends
Ex dividend date
• Normally one days before the record date. New investors after this
date will not be registered as owner in time for the record date. (So
on this date, the stock price normally falls by the amount of the
dividend
Payment Date
• The date when the dividend is paid to the registered shareholders on
the record date
Dividend Payments
16-6
Dividend Payment
16-7
Dividend restrictions (protection of creditors)

• Example: US: Companies are not allowed pay
out dividends if shareholders equity falls below
legal capital (par value of all outstanding shares).
Dividend Payout frequency

• In the US, often quarterly
• In Europe, Japan: 1-2 times per year
Dividend Payment
16-8
How dividend is paid

Declaration date
• The company declare how much dividend will be paid out
Record date
• Investors registered as shareholders on this date will receive the
dividends
Ex dividend date
• Normally two days before the record date. New investors after this
date will not be registered as owner in time for the record date. (So
on this date, the stock price normally falls by the amount of the
dividend
Payment Date
• The date when the dividend is paid to the registered shareholders on
the record date
Dividend Payments
16-9
Dec.15, 2014 Feb. 4, 2015 Feb. 6, 2015 Mar. 3, 2015
Pfizer Dividend will be

Shares start to Dividend checks
declares regular paid
trade ex are mailed
quarterly dividend to shareholders
dividend. to shareholders.
of $.28 per share. registered
on this date.
Declaration Ex-dividend Record Payment

date date date date
Dividend Payment
16-10
Dividend restrictions (protection of creditors)

• Example: US: Companies are not allowed pay
out dividends if shareholders equity falls below
legal capital (par value of all outstanding shares).
Dividend Payout frequency

• In the US, often quarterly
• In Europe, Japan: 1-2 times per year
Online exercise 17: Chevron CEO says
dividends is no 1 priority
16-11
Read the article and upload answers in Online

Assignment 17 folder
1. Why is Chevron’s business in a difficult position?
2. What has Chevron decided to with its share buy

back and dividend payout programs?
How Firms Pay Dividends
16-12
Stock Dividend - Distribution of additional

shares to a firm’s stockholders
Cash Dividend - Payment of cash by the firm to

its shareholders
-Regular
-Special
How Firms Pay Dividends
16-13
Stock Splits - Issue of additional shares to firm’s

stockholders. Reduction in the par value per share
but total shareholder’s equity remain the same.
The Information Content of Dividends
16-14
Senior Executive Dividend Policy Features

(How Dividends are Determined)
1. Managers are reluctant to make dividend changes
that might have to be reversed
2. Managers “smooth” dividends and hate to cut
them. Dividends changes follow shifts in long-run,
sustainable levels of earnings.
3. Managers focus more on dividend changes than
on absolute levels
The Information Content of Dividends
16-15
Dividend increases are normally considered good

news
• Managers normally don’t like to reduce dividends

• Companies normally don’t increase dividends
unless they are confident they can be maintained
• Signals confidence in rising future profits
Rising dividend implies rising future profits and

often leads to a rise in the stock price
The Payout Decision
16-16
Dividend Decision Survey (2004)
The Information Content of Share
repurchases
16-17
• Share repurchases are not seen as commitment

that continues in the future
• May receive a positive reaction if investors worry

that the company instead would use the cash for
low return investments
• May be taken as a sign that management views

the share price as undervalued
How Firms Repurchase Stock
16-18
Stock Repurchase - Firm buys back stock from

its shareholders
4 methods
1. Buy shares on the market
• Most common way
2. Tender offer to shareholders
• Offer to buy back share at price that higher than the
market price
How Firms Repurchase Stock (cont)
16-19
3. Dutch auction
• A company states a series of prices it is willing to
buy at and shareholders can indicate which price
they willing sell at. The company set the price
where it can the desired number of shares (example
wanted buy 1,000 shares)
Number of shares
Share price offered by shareholders
60 1400
58 1200
56 1000
54 900
52 800
4. Private negotiation
• Direct negotiation with a major shareholder
Share repurchase
16-20
• In theory, the stock price should stay unchanged when

the company buys back its own shares
Share repurchase
16-21
Example
• Outstandings shares: 1,000,000
• Stock price 11
• Market value: 11,000,000
The company want do a share repurchase of 1,000,000

• Number of shares repurchased 1,000,000/11 = 90,090
• Total equity = 11,000,000 – 1,000,000 = 10,000,000
• Remaining shares outstanding: 1,000,000 – 90,090 = 909,910
• Price per share: 10,000,000/909,910 = 11
Dividends payment
16-22
• In theory, the stock price should fall by the amount of the

dividends
• Example: The company pays out $1mn in dividends. Total
assets and equity fall from $11mn to $10mn
Class exercise
16-23
ABC Company has the following balance sheet information
ABC Company (in $ Million)

Surplus cash 2.0 2.0 Debt
Fixed assets and 10.0 10.0 Equity
Net working capital
12.0 12.0
It has 1,000,000 shares outstanding and its stock price is $10
• Calculate what its share price should be if is pays out $2/share

as dividends
• Calculate what its share price should be if it instead uses the
same amount to repurchase shares
Class exercise solution
16-24
Assumptions
Original
Asset value 12000000
Debt value 2000000
Equity value 10000000
Starting number of shares 1000000
Starting share price 10
Dividend payout Share repurchase

Original asset value 12000000 Original asset value 12000000
- cash used for dividend payout 2000000 - cash used for share repurchase 2000000
New asset value 10000000 New asset value 10000000
-debt value 2000000 -debt value 2000000
= New Equity value 8000000 = New Equity value 8000000
Number of shares 1000000 shares bought 200000

New share price 8 New number of shares 800000
New share price 10
Online Assignment 18
16-25
Company ABC has been paying regular dividend per

share of $4 for over 10 years
It is paying all profits out as dividends and is not expected
to grow
It has 100,000 share outstanding and the share price is
$80
Now the company instead changes to use its profit to
repurchase shares
1. What is the investor’s annual return in the current

situation
2. Calculate would be the number of shares that it would
repurchase and the expected share price for year 1,
year 2 and year 3.
Online Assignment 18
16-26
Company ABC has been paying regular dividend per

share of $4 for over 10 years
It is paying all profits out as dividends and is not expected
to grow
It has 100,000 share outstanding and the share price is
$80
Now the company instead changes to use its profit to
repurchase shares
1. What is the investor’s annual return in the current

situation
2. Calculate would be the number of shares that it would
repurchase and the expected share price for year 1,
year 2 and year 3.
Exercise 18 solution
16-27
Assumptions Question 1
Dividend per share 4 Dividends in year 0
Number of shares 100,000 Return (400,000/8,000,000) 5.0% Return (400,000/8,000,000)
Stock price 80
Total dividends 400,000 Question 2
Equity value 8,000,000 No dividends from 1 year
Stock price 84 (8,000,000+400,000)/100,000
Shares repurchased 4,761.90 (400,000/84)
New number of shares 95,238.10 (100,000-4,761.90)
Share price year 1 84 (8,000,000/95,238.10)
Stock price in year 2 88.2 (8,000,000+400,000)/95,238.10

Share repurchased 4,535.15 (400,000/88.2)
New number of shares 90,702.95 (95,238.10-4,535.15)
New share price 88.2 (8,000,000/90,702.95)
Stock price in year 3 92.61 (8000000+400000)/90,702.95

Share repurchased 4,319.19 (400,000/92.61)
New number of shares 86.383.76 (90,702.95-4,319.19)
New share price 92.61 (8,000,000/86,383.76))
Stock Repurchases and Dividends
16-28
If the tax rate on dividends and capital gain is the

same
• In theory, it shouldn’t matter whether the
company pays dividend or repurchase shares
• But some groups prefer high dividends

o Older people needing regular income
o Some institutions are restricted from holding stocks
that don’t pay regular dividends
Payout policy and management incentives
16-29
Most convincing argument in favor of paying

dividends is that it prevents managers from misusing
or wasting cash on bad or low return projects
The willingness of companies to make dividend

payouts show corporate governance works in the US
and other developed countries (make decisions
based on the best interest of shareholders). Effective
if top management also hold company shares
But corporate governance is less effective in

Emerging Market countries where dividend payouts
tend to be smaller
Stock Repurchases and DCF Models of
Share Price
16-30
Market Capitalization
• A company’s market capitalization will not be impacted

by how payouts are split between dividends and share
repurchases
• Shifting payout to repurchases will reduce total

dividends. But this is offset by the lower number of
shares which increases the dividend per share
Dividends and DCF Models of Share Price
16-31
Example
• Constant payout of $1,000,000 per year in the future
• Cost of capital: 10%
• Total shares outstanding: 1,000,000
• Share price: 10
Share price calculation

This is a perpetuity
• D1: dividend, year 1
• k: Cost of capital
16-32
Example
• Constant payout of $1,000,000 per year in the future
• Share price: 10
Share price calculation

16-33
Example
• Constant payout of $500,000 per year in the future
• Share repurchases of $500,000
• Share price: 10
Present value of the company

• g: dividend growth rate
• Dividend growth rate is 5% (constant dividend is 500,000 and number of shares
reduced by 5%)
16-34
Example
• Constant payout of $500,000 per year in the future
• Share repurchases of $500,000
• Share price: 10
Present value of the company

• g: g: dividend growth rate
• Dividend growth rate is 5% (constant dividend is 500,000 and number of shares
reduced by 5%)
Dividends Decrease Value
16-35
Tax Consequences
Companies can convert dividends into capital
gains by shifting their dividend policies. If
dividends are taxed more heavily than capital
gains, taxpaying investors should welcome such a
move and value the firm more favorably.
In such a tax environment, the total cash flow

retained by the firm and/or held by shareholders
will be higher than if dividends are paid.
Payout policy and the life cycle of the firm
16-36
Young growth firms normally have many

profitable investment opportunities
o Most efficient to retain all operating cashflows and
reinvest them in the business.
As the companies matures
o Positive NPV project become fewer and firms the
cash position begins to increase
o Potential pressure from investors on company to
start paying out excess cash to shareholders
o The company start paying out cash as dividends or
share repurchases
Payout Policy and the Life Cycle of the
Firm
16-37
Questions for the Financial Manager

1. Is the company generating positive free cash flow
after making all investments with positive NPVs and is
the positive free cash flow likely to continue?
2. Is the firm’s debt ratio prudent?
3. Are the company’s holdings of cash a sufficient
cushion for unexpected setbacks and a sufficient war
chest for unexpected opportunities?
Actions
• If debt ratio high, pay down debt first
• If the answer is yes to all 3 questions, the company
should start paying out dividends or buying back shares
Class demonstration
16-38
Go to www.investing.com to answer the following

questions
1. When did Microsoft share last go ex dividend and
when was the dividend actually paid
2. What is Microsoft dividend payout ratio
3. How much has Microsoft paid out in total
dividends and share repurchase from 2017-20
Class demonstration
16-39

questions
Class demonstration
16-40

questions
Class demonstration
16-41
How to calculate dividend payout
Payout ratio = DPS/EPS

* DPS: Dividend per share
* EPS: Earnings per share
Class demonstration
16-42
How to calculate dividend payout

Payout ratio = DPS/EPS
Microsoft Quarterly
Date DPS EPS Payout
May 19, 2021 0,56 1,78 31,5%
Feb 17, 2021 0,56 2,03 27,6%
Nov 18, 2020 0,56 1,82 30,8%
Aug 19, 2020 0,51 1,46 34,9%
May 20, 2020 0,51 1,40 36,4%
Feb 19, 2020 0,51 1,51 33,8%
* May 19, 2021 is a forecast
Class demonstration
16-43

questions
Class demonstration
16-44

questions
4. What happened to Microsoft’s cash amount from
2017-2020
Online Assignment 19: Apple start to pay
dividends and buy back shares
16-45
Read the article to answer question 1 and 2 and use

investing.com to answer question 3, 4 and 5
1. Why did Apple start to payout its cash as dividends and
share repurchases?
2. Why do you think that Apple’s stock price rose after the
announcement to start paying dividends and buy back
shares
3. What was Apple’s dividend payout ratio in the last 3
quarters
4. What happened to Apple’s payout of total dividends and to
share repurchases from 2017-2020
5. What happened to Apple’s total amount of cash
(cash+short term investments) from 2017-2020

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Ch 16: Today’s Agenda

Chapter 16: Payout policy

Payout policy deals with two questions

1.How much cash should the company pay out to

Cash dividend vs stock repurchases

Average each year for

• Both dividend and share repurchases have risen

How dividend is paid

Dividend restrictions (protection of creditors)

Dividend Payout frequency

How dividend is paid

Dec.15, 2014 Feb. 4, 2015 Feb. 6, 2015 Mar. 3, 2015

Pfizer Dividend will be

Declaration Ex-dividend Record Payment

Dividend restrictions (protection of creditors)

Dividend Payout frequency

Read the article and upload answers in Online

1. Why is Chevron’s business in a difficult position?

2. What has Chevron decided to with its share buy

Stock Dividend - Distribution of additional

Cash Dividend - Payment of cash by the firm to

Stock Splits - Issue of additional shares to firm’s

Senior Executive Dividend Policy Features

Dividend increases are normally considered good

• Managers normally don’t like to reduce dividends

Rising dividend implies rising future profits and

Dividend Decision Survey (2004)

• Share repurchases are not seen as commitment

• May receive a positive reaction if investors worry

• May be taken as a sign that management views

Stock Repurchase - Firm buys back stock from

• In theory, the stock price should stay unchanged when

The company want do a share repurchase of 1,000,000

• In theory, the stock price should fall by the amount of the

ABC Company has the following balance sheet information

ABC Company (in $ Million)

It has 1,000,000 shares outstanding and its stock price is $10

• Calculate what its share price should be if is pays out $2/share

Dividend payout Share repurchase

Number of shares 1000000 shares bought 200000

Company ABC has been paying regular dividend per

1. What is the investor’s annual return in the current

Company ABC has been paying regular dividend per

1. What is the investor’s annual return in the current

Stock price in year 2 88.2 (8,000,000+400,000)/95,238.10

Stock price in year 3 92.61 (8000000+400000)/90,702.95

If the tax rate on dividends and capital gain is the

• But some groups prefer high dividends

Most convincing argument in favor of paying

The willingness of companies to make dividend

But corporate governance is less effective in

• A company’s market capitalization will not be impacted

• Shifting payout to repurchases will reduce total

Share price calculation

Share price calculation

Present value of the company

Present value of the company

In such a tax environment, the total cash flow

Young growth firms normally have many

Questions for the Financial Manager

Go to www.investing.com to answer the following

Go to www.investing.com to answer the following

Go to www.investing.com to answer the following