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# Chapter

Dividend Policy

Dividend

## Cash distributions made to stockholders

from the firms earnings.

## The dividend policy that strikes a balance

between current dividends and future
growth and maximizes the firms stock
price is known as optimal dividend policy.

Procedures

## When a firms directors declare a dividend, they issue a

statement indicating the dividend amount and setting
three important dates Date of record (Dividends): the date on which all
persons whose names are recorded as stockholders
receive a declared dividend at a specified future time.
Ex Dividend: A period beginning 2 business days prior
to the date of record, during which a stock is sold
without the right to receive the current dividend.
Payment Date: The actual date on which the firm
mails the dividend payment to the holders of record.

Example

## On June 24, 2010, the board of directors

of Best Buy announced that the firms next
quarterly cash dividend would be \$ 0.15
per share, payable on October 25, 2010 to
shareholders of record on Tuesday,
October 5, 2010. Best Buy shares would
begin trading ex dividend on the previous
Friday, October 1. At the time of the
announcement, Best Buy had 420 million
shares.

Example
Cash \$1,826,000
Dividend Payable \$0
Retained Earning \$ 5,797,000

## Significance of dividend policy

on share price

Dividend
Irrelevant
Theory:
Miller
and
Modigliani's theory that in a perfect world, the
firms value is determined sololy by the earning
power and risk of its assets (investments) and
that the manner in which it splits its earnings
stream between dividends and internally retained
(and invested) funds does not affect this value.

## Dividend Relevance Theory: The theory, advanced

by Gordon and Lintner, that there is a direct
relationship between a firms dividend policy and
its market value.

## Stock Price Reactions To

Corporate Payouts

## With cash dividend, price of share

decreases just by the amount of dividend.

not be affected.

## Types of Dividend Payments

Residual Theory Of Dividends: A school of
thought that suggest that the dividend paid
by a firm should be viewed as a residualthe amount left over after all acceptable
investment opportunities have been
undertaken.
Steps Of The Residual Theory Of Dividends:
Step 1-Determine its optimal level of
capital expenditures, which would be the
level that exploits all of a firms positive
NPV projects.

## Step 2-Using the optimal capital structure

proportions, estimate the total amount if
equity financing needed to support the
expenditures generated in step 1.
Step3-Because the cost of retained earning
r n is less than the cost of new common
stock, r m use retained earnings to meet
the equity requirement determined in step
2. After that distribute the residual of
retained earnings as dividend.

## Types Of Dividend policies

Dividend Payout
Dividend Payout Ratio: Indicates the
percentage of each dollar earned that a
firm distributes to its owners in the form
of cash. It is calculated by dividing the
firms cash dividend per share by its
earnings per share.
Constant-Payout-Ratio Dividend policy: A
dividend policy based on the payment of a
certain percentage of earnings to owners
in each dividend period.

Dividend Payout

## Regular Dividend Policy: A dividend policy

based on the payment of a fixed-amount
dividend in each year.

Share Repurchase
procedures

## Open-market share repurchase: A share

repurchase program in which firms simply
buy back some of their outstanding shares
on the open market.
Tender offer repurchase: A repurchase
program in which a firm offers to repurchase
a fixed number of shares, usually at a
premium relative to the market value, and
shareholders decide whether or not they
want to sell back their shares at that price.
Dutch Auction Repurchase

Dividend Reinvestment
Plans (DRIPs)
Plans that enable stockholders to use
dividends received on the firms stock to
acquire additional shares-even fractional
shares-at little or no transaction cost.
Clearly the existence of DRIP enables
firms to issue new shares to participants
more
economically,
avoiding
the
underpricing and flotation cost.

## Stock Dividend: The payment, to existing

owners, of a dividend in the form of stock.