Payout Policy Revised

Chapter 14
Payout Policy
Copyright © 2012 Pearson Prentice Hall.

All rights reserved.
Learning Goals
LG1 Understand cash payout procedures, their tax

treatment, and the role of dividend reinvestment
plans.
LG2 Describe the residual theory of dividends and the key

arguments with regard to dividend irrelevance and
relevance.
LG3 Discuss the key factors involved in establishing a

dividend policy.
© 2012 Pearson Prentice Hall. All rights reserved. 14-2

Learning Goals (cont.)
LG4 Review and evaluate the three basic types of dividend

policies.
LG5 Evaluate stock dividends from accounting,

shareholder, and company points of view.
LG6 Explain stock splits and the firm’s motivation for

undertaking them.

The Basics of Payout Policy:
Elements of Payout Policy
The term payout policy refers to the decisions that a firm
makes regarding whether to distribute cash to shareholders,
how much cash to distribute, and the means by which cash
should be distributed.

Figure 14.1 Per Share Earnings and
Dividends of the S&P500 Index

Matter of Fact
P&G’s Dividend History

– Few companies have replicated the dividend achievements of the consumer
products giant, Procter & Gamble (P&G). P&G has paid dividends every
year for more than a century, and it increased its dividend in every year from
1956–2010.

Figure 14.2 Aggregate Dividends and
Repurchases for All U.S.-Listed Companies

Matter of Fact
Share Repurchases Gain Worldwide Popularity

– In most of the world’s largest economies, repurchases have been
on the rise in recent years, exceeding dividend payments at least
some of the time in countries as diverse as Belgium, Denmark,
Finland, Hungary, Ireland, Japan, Netherlands, South Korea, and
Switzerland.
– A recent study of payout policy at firms from 25 different
countries found that share repurchases rose at an annual rate of
19% from 1999–2008.

The Mechanics of Payout Policy:
Cash Dividend Payment Procedures
• At quarterly or semiannual meetings, a firm’s board of directors
decides whether and in what amount to pay cash dividends.
• If the firm has already established a precedent of paying dividends,
the decision facing the board is usually whether to maintain or
increase the dividend, and that decision is based primarily on the
firm’s recent performance and its ability to generate cash flow in
the future.
• Boards rarely cut dividends unless they believe that the firm’s
ability to generate cash is in serious jeopardy.

Figure 14.3 U.S. Firms Increasing or
Decreasing Dividends

The Mechanics of Payout Policy: Cash
Dividend Payment Procedures (cont.)
• The date of record (dividends) is set by the firm’s directors, the

date on which all persons whose names are recorded as
stockholders receive a declared dividend at a specified future time.
• A stock is ex dividend for 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.
• The payment date is set by the firm’s directors, the actual date on
which the firm remit the dividend payment to the holders of record.

Figure 14.4
Dividend Payment Time Line

On June 24, 2010, the board of directors of Best Buy

announced that the firm’s next quarterly cash dividend
would be $0.15 per share, payable October 26 to
shareholders of record on October 5. At the time, Best Buy
had 420,061,666 shares of common stock outstanding.
Before the dividend was declared, the key accounts of the
firm were as follows (dollar values quoted in thousands):
– Cash: $1,826,000
– Dividends payable: $0
– Retained earnings: $5,797,000

When the dividend was announced by the directors, $63

million of the retained earnings ($0.15 per share  420
million shares) was transferred to the dividends payable
account. The key accounts thus became:
– Cash: $1,826,000
– Dividends payable: $63,000

When Best Buy actually paid the dividend on October 26,

this produced the following balances in the key accounts of
the firm:
– Cash: $1,763,000
– Dividends payable: $0
The net effect of declaring and paying the dividend was to
reduce the firm’s total assets (and stockholders’ equity) by
$63 million.

Share Repurchase Procedures
• Common methods for repurchasing shares include:
– An open-market share repurchase is a share repurchase program in which
firms simply buy back some of their outstanding shares on the open market.
– A tender offer repurchase is 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.
– A Dutch Auction repurchase is a repurchase method in which the firm
specifies how many shares it wants to buy back and a range of prices at
which it is willing to repurchase shares. Investors specify how many shares
they will sell at each price in the range, and the firm determines the
minimum price required to repurchase its target number of shares. All
investors who tender receive the same price.

Share Repurchase Procedures (cont.)

The Mechanics of Payout Policy: Tax Treatment
of Dividends and Repurchases
• For many years, dividends and share repurchases had very different
tax consequences.
– The dividends that investors received were generally taxed at ordinary
income tax rates.
– On the other hand, when firms repurchased shares, the taxes triggered by that
type of payout were generally much lower.
• Shareholders who did not participate did not owe any taxes.
• Shareholders who did participate in the repurchase program might not owe any
taxes on the funds they received if they sold their shares at a loss.
• Shareholders who participated in the repurchase program and sold their shares for
a profit only paid taxes at the (usually lower) capital gains tax rate, and even that
tax only applied to the gain, not to the entire value of the shares repurchased.

The Mechanics of Payout Policy: Tax Treatment
of Dividends and Repurchases
The Jobs and Growth Tax Relief Reconciliation Act of 2003

significantly changed the tax treatment of corporate dividends for
most taxpayers.
– The act reduced the tax rate on corporate dividends for most taxpayers to the
tax rate applicable to capital gains, which is a maximum rate of 5 percent to
15 percent, depending on the taxpayer’s tax bracket.
– This change significantly diminishes the degree of “double taxation” of
dividends, which results when the corporation is first taxed on its income and
then when the investor who receives the dividend is also taxed on it.
– After-tax cash flow to dividend recipients is much greater at the lower
applicable tax rate; the result is noticeably higher dividend payouts by
corporations today than prior to passage of the 2003 legislation.

Focus on Practice
Capital Gains and Dividend Tax Treatment Extended to 2010

– In May 2003, President George W. Bush signed into law the Jobs and
Growth Tax Relief Reconciliation Act of 2003 (JGTRRA).
– Prior to that new law, dividends were taxed once as part of corporate
earnings, and again as the personal income of the investor, in both cases with
a potential top rate of 35 percent. The result was an effective tax rate of
57.75 percent on some dividends.
– Though the 2003 tax law did not completely eliminate the double taxation of
dividends, it reduced the maximum possible effect of the double taxation of
dividends to 44.75 percent. For taxpayers in the lower tax brackets, the
combined effect was a maximum of 38.25 percent.

Personal Finance Example
The board of directors of Espinoza Industries, Inc., on

October 4 of the current year, declared a quarterly dividend
of $0.46 per share payable to all holders of record on Friday,
October 30. They set a payment date of November 19. Rob
and Kate Heckman, who purchased 500 shares of Espinoza’s
common stock on Thursday, October 15, wish to determine
whether they will receive the recently declared dividend
and, if so, when and how much they would net after taxes
from the dividend given that the dividends would be subject
to a 15% federal income tax.

(cont.)
Given the Friday, October 30 date of record, the stock would begin
selling ex dividend 2 business days earlier on Wednesday, October 28.
Purchasers of the stock on or before Tuesday, October 27, would
receive the right to the dividend. Because the Heckmans purchased the
stock on October 15, they would be eligible to receive the dividend of
$0.46 per share.
Thus, the Heckmans will receive $230 in dividends
($0.46 per share  500 shares), which will be remitted to them
on the November 19 payment date.
Because they are subject to a 15% federal income tax on the
dividends, the Heckmans will net $195.50 [(1 – 0.15)  $230]
after taxes from the Espinoza Industries dividend.

Dividend Reinvestment Plans
Dividend reinvestment plans (DRIPs) are plans that enable
stockholders to use dividends received on the firm’s stock to acquire
additional shares at little or no transaction cost.
– Companies allow investors to make their purchases of the firm’s stock
directly from the company without going through a broker.
– With DRIPs, plan participants typically can acquire shares at about 5 percent
below the prevailing market price.

The Mechanics of Payout Policy: Stock
Price Reactions to Corporate Payouts
• What happens to the stock price when a firm pays a

dividend or repurchases shares?
– In theory, when a stock begins trading ex dividend, the stock
price should fall by exactly the amount of the dividend.
– In theory, when a firm buys back shares at the going market
price, the market price of the stock should remain the same.
– In practice, taxes and a variety of other market imperfections
may cause the actual change in share price in response to a
dividend payment or share repurchase to deviate from what we
expect in theory.

Relevance of Payout Policy
• The financial literature has reported numerous theories and

empirical findings concerning payout policy.
• Although the existing researches provides some interesting insights
about payout policy, capital budgeting and capital structure
decisions are generally considered far more important than payout
decisions.
• In other words, firms should not sacrifice good investment and
financing decisions for a payout policy of questionable importance.
• The most important question about payout policy is this: Does
payout policy have a significant effect on the value of a firm?

Relevance of Payout Policy:
Residual Theory of Dividends
The residual theory of dividends is a school of thought that suggests
that the dividend paid by a firm should be viewed as a residual—the
amount left over after all acceptable investment opportunities have
been undertaken.

Relevance of Payout Policy: Residual
Theory of Dividends (cont.)
Using the residual theory of dividends, the firm would treat the
dividend decision in three steps, as follows:
– Determine its optimal level of capital expenditures, which would be the level
that exploits all of a firm’s positive NPV projects.
– Using the optimal capital structure proportions, estimate the total amount of
equity financing needed to support the expenditures generated in Step 1.
– Because the cost of retained earnings, rr, is less than the cost of new common
stock, rn, use retained earnings to meet the equity requirement determined in
Step 2. If retained earnings are inadequate to meet this need, sell new bonds
or common stock. If the available retained earnings are in excess of this
need, distribute the surplus amount—the residual—as dividends.

The Dividend Irrelevance Theory
The dividend irrelevance theory is Miller and Modigliani’s theory
that in a perfect world, the firm’s value is determined solely 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 reinvested) funds does not affect this value.
– In a perfect world (certainty, no taxes, no transactions costs, and no other
market imperfections), the value of the firm is unaffected by the distribution
of dividends.
– Of course, real markets do not satisfy the “perfect markets” assumptions of
Modigliani and Miller’s original theory.

Homemade Dividend Example
• An investor bought 1000 shares of Microsoft at $ 250 in

March 2018. By September 2018 the share price rose to
$ 400 and the Company did not announce any dividend.
• The investor had an objective to generate $ 4000 of cash
by November end, hence he sold 10 shares of Microsoft
at $ 400 and generated a homemade dividend of $ 4000.
• The investor is left with $ 396000 of shareholding after he
sold the shares. Thus, the no dividend policy of Microsoft
did not affect the investor from taking home a
“homemade dividend”.

Homemade Dividend Example
• Assume that Microsoft had declared a dividend of $ 4 per

share. Now, after the ex-dividend date, the shares of the
Company will be at a price at $ 396 (after deducting the
dividend from the price of the shares).
• Thus, the investor now will have $ 4000 as dividend and
1000 shares @ $ 396 making his shareholding at $ 396000.
• This is assumed that there are no capital gains taxes,
dividend taxes or brokerage. However, this scenario will
change after we include these charges an investor might
not be indifferent to receiving the dividend or generating a
homemade dividend.

The Dividend Irrelevance Theory (cont.)
The clientele effect is the argument that different payout policies

attract different types of investors but still do not change the value of
the firm.
– Tax-exempt investors may invest more heavily in firms that pay dividends
because they are not affected by the typically higher tax rates on dividends.
– Investors who would have to pay higher taxes on dividends may prefer to
invest in firms that retain more earnings rather than paying dividends.
– If a firm changes its payout policy, the value of the firm will not change—
what will change is the type of investor who holds the firm’s shares.

Arguments for Dividend Relevance
• Dividend relevance theory is the theory, advanced by Gordon and
Lintner, that there is a direct relationship between a firm’s dividend
policy and its market value.
• The bird-in-the-hand argument is the belief, in support of
dividend relevance theory, that investors see current dividends as
less risky than future dividends or capital gains.

Relevance of Payout Policy: Arguments
for Dividend Relevance (cont.)
Studies have shown that large changes in dividends do affect

share price.
– Informational content is the information provided by the
dividends of a firm with respect to future earnings, which causes
owners to bid up or down the price of the firm’s stock.
– The agency cost theory says that a firm that commits to paying
dividends is reassuring shareholders that managers will not
waste their money.
– Although many other arguments related to dividend relevance
have been put forward, empirical studies have not provided
evidence that conclusively settles the debate about whether and
how payout policy affects firm value.

Factors Affecting Dividend
Policy
Dividend policy represents the firm’s plan of action to be
followed whenever it makes a dividend decision.
First consider five factors in establishing a dividend policy:
1. legal constraints
2. contractual constraints
3. the firm’s growth prospects
4. owner considerations
5. market considerations

Policy: Legal Constraints
• Most states prohibit corporations from paying out as cash dividends
any portion of the firm’s “legal capital,” which is typically measured
by the par value of common stock.
• Other states define legal capital to include not only the par value of
the common stock, but also any paid-in capital in excess of par.
• These capital impairment restrictions are generally established to
provide a sufficient equity base to protect creditors’ claims.

Factors Affecting Dividend Policy:
Legal Constraints (cont.)

Factors Affecting Dividend Policy:
Legal Constraints (cont.)
• If a firm has overdue liabilities or is legally insolvent or
bankrupt, most states prohibit its payment of cash
dividends.
• In addition, the Internal Revenue Service prohibits firms
from accumulating earnings to reduce the owners’ taxes.
– The excess earnings accumulation tax is the tax the IRS levies
on retained earnings above $250,000 for most businesses when
it determines that the firm has accumulated an excess of
earnings to allow owners to delay paying ordinary income taxes
on dividends received.

Policy: Contractual Constraints
• Often the firm’s ability to pay cash dividends is
constrained by restrictive provisions in a loan agreement.
• Generally, these constraints prohibit the payment of cash
dividends until the firm achieves a certain level of
earnings, or they may limit dividends to a certain dollar
amount or percentage of earnings.
• Constraints on dividends help to protect creditors from
losses due to the firm’s insolvency.

Policy: Growth Prospects
• A growth firm is likely to have to depend heavily on
internal financing through retained earnings, so it is likely
to pay out only a very small percentage of its earnings as
dividends.
• A more established firm is in a better position to pay out a
large proportion of its earnings, particularly if it has ready
sources of financing.

Policy: Owner Considerations
Tax status of a firm’s owners:
– If a firm has a large percentage of wealthy stockholders who have sizable
incomes, it may decide to pay out a lower percentage of its earnings to allow
the owners to delay the payment of taxes until they sell the stock.
Owners’ investment opportunities:

– If it appears that the owners have better opportunities externally, the firm
should pay out a higher percentage of its earnings.
Potential dilution of ownership:
– If a firm pays out a high percentage of earnings, new equity capital will have
to be raised with common stock in the future. The result of a new stock issue
may be dilution of both control and earnings for the existing owners.

Policy: Market Considerations
Catering theory is a theory that says firms cater to the
preferences of investors, initiating or increasing dividend
payments during periods in which high-dividend stocks are
particularly appealing to investors.

Types of Dividend Policies: Constant-
Payout-Ratio Dividend Policy
• A firm’s dividend payout ratio indicates the percentage

of each dollar earned that a firm distributes to the owners
in the form of cash. It is calculated by dividing the firm’s
cash dividend per share by its earnings per share.
• A constant-payout-ratio dividend policy is a dividend
policy based on the payment of a certain percentage of
earnings to owners in each dividend period.

Types of Dividend Policies: Constant-
Payout-Ratio Dividend Policy (cont.)

Types of Dividend Policies:
Regular Dividend Policy
• Regular dividend policy is a dividend policy based on
the payment of a fixed-dollar dividend in each period.
• A regular dividend policy is often build around a target
dividend-payout ratio, which is a dividend policy under
which the firm attempts to pay out a certain percentage of
earnings as a stated dollar dividend and adjusts that
dividend toward a target payout as proven earnings
increases occur.

Regular Dividend Policy (cont.)

Low-Regular-and-Extra Dividend Policy
• A low-regular-and-extra dividend policy is a dividend

policy based on paying a low regular dividend,
supplemented by an additional (“extra”) dividend when
earnings are higher than normal in a given period.
• An extra dividend is an additional dividend optionally
paid by the firm when earnings are higher than normal in
a given period.

Other Forms of Dividends
A stock dividend is the payment, to existing owners, of a dividend in

the form of stock.
– In a stock dividend, investors simply receive additional shares in proportion
to the shares they already own.
– No cash is distributed, and no real value is transferred from the firm to
investors.
– Instead, because the number of outstanding shares increases, the stock price
declines roughly in line with the amount of the stock dividend.
– In an accounting sense, the payment of a stock dividend is just a shifting of
funds between stockholders’ equity accounts rather than an outflow of funds.

(cont.)
The current stockholders’ equity on the balance sheet of
Garrison Corporation, a distributor of prefabricated cabinets,
is as shown in the following accounts.
Preferred stock $300,000
Common stock (100,000 shares @ $4 par) 400,000
Paid-in capital in excess of par 600,000
Retained earnings 700,000
Total stockholders’ equity $2,000,000

(cont.)
Garrison declares a 10% stock dividend when the market
price of its stock is $15 per share. The resulting account
balances are as follows:
Preferred stock $300,000
Common stock (110,000 shares @ $4 par) 440,000
Paid-in capital in excess of par 710,000
Retained earnings 550,000
Total stockholders’ equity $2,000,000

(cont.)
Ms. X owned 10,000 shares of Garrison Corporation’s stock.
– The company’s most recent earnings were $220,000, and earnings are not
expected to change in the near future.
– Before the stock dividend, Ms. X owned 10% of the firm’s stock, which was
selling for $15 per share.
– Because Ms. X owned 10,000 shares, her shares of earnings were $22,000
($2.20 per share  10,000 shares).
– After receiving the 10% stock dividend, Ms. X has 11,000 shares, which
again is 10% of the ownership (11,000 shares ÷ 110,000 shares).
– The market price of the stock can be expected to drop to $13.64 per share
[$15  (1.00 ÷ 1.10)], which means that the market value of Ms. X’s holdings
is $150,000 (11,000 shares  $13.64 per share).
– The future earnings per share drops to $2.

(cont.)
A stock split is a method commonly used to lower the
market price of a firm’s stock by increasing the number of
shares belonging to each shareholder.
– Stock splits are often made prior to issuing additional stock to
enhance that stock’s marketability and stimulate market activity.
– A reverse stock split is a method used to raise the market price
of a firm’s stock by exchanging a certain number of outstanding
shares for one new share.

(cont.)

Shakira Washington, a single investor in the 25% federal income tax

bracket, owns 260 shares of Advanced Technology, Inc., common
stock. She originally bought the stock 2 years ago at its initial public
offering (IPO) price of $9 per share. The stock of this fast-growing
technology company is currently trading for $60 per share, so the
current value of her Advanced Technology stock is $15,600
(260 shares  $60 per share). Because the firm’s board believes that
the stock would trade more actively in the $20 to $30 price range, it
just announced a 3-for-1 stock split. Shakira wishes to determine the
impact of the stock split on her holdings and taxes.

(cont.)
• Because the stock will split 3 for 1, after the split Shakira
will own 780 shares (3  260 shares).
• She should expect the market price of the stock to drop to
$20 (1/3  $60) immediately after the split; the value of
her after-split holding will be $15,600 (780 shares  $20
per share).
• Because the $15,600 value of her after-split holdings in
Advanced Technology stock exactly equals the before-
split value of $15,600, Shakira has experienced neither a
gain nor a loss on the stock as a result of the 3-for-1 split.

Review of Learning Goals
LG1 Understand cash payout procedures, their tax treatment, and

the role of dividend reinvestment plans.
– The board of directors makes the cash payout decision and, for
dividends, establishes the record and payment dates. As a result of a
tax-law change in 2003, most taxpayers pay taxes on corporate
dividends at a maximum rate of 5 percent to 15 percent, depending on
the taxpayer’s tax bracket. Some firms offer dividend reinvestment
plans that allow stockholders to acquire shares in lieu of cash
dividends.

(cont.)
LG2 Describe the residual theory of dividends and the key
arguments with regard to dividend irrelevance and relevance.
– The residual theory suggests that dividends should be viewed as the
earnings left after all acceptable investment opportunities have been
undertaken. Miller and Modigliani argue in favor of dividend
irrelevance, using a perfect world wherein information content and
clientele effects exist. Gordon and Lintner advance the theory of
dividend relevance, basing their argument on the uncertainty-reducing
effect of dividends, supported by their bird-in-the-hand argument.
Empirical studies fail to provide clear support of dividend relevance.
Even so, the actions of financial managers and stockholders tend to
support the belief that dividend policy does affect stock value.

(cont.)
LG3 Discuss the key factors involved in establishing a dividend
policy.
– A firm’s dividend policy should provide for sufficient financing and
maximize stockholders’ wealth. Dividend policy is affected by legal
and contractual constraints, by growth prospects, and by owner and
market considerations. Growth prospects affect the relative importance
of retaining earnings rather than paying them out in dividends. The tax
status of owners, the owners’ investment opportunities, and the
potential dilution of ownership are important owner considerations.
Finally, market considerations are related to the stockholders’
preference for the continuous payment of fixed or increasing streams of
dividends.

(cont.)
LG4 Review and evaluate the three basic types of dividend
policies.
– With a constant-payout-ratio dividend policy, the firm
pays a fixed percentage of earnings to the owners each
period; dividends move up and down with earnings, and
no dividend is paid when a loss occurs. Under a regular
dividend policy, the firm pays a fixed-dollar dividend each
period; it increases the amount of dividends only after a
proven increase in earnings. The low-regular-and-extra
dividend policy is similar to the regular dividend policy,
except that it pays an extra dividend when the firm’s
earnings are higher than normal.

(cont.)
LG5 Evaluate stock dividends from accounting, shareholder, and
company points of view.
– Firms may pay stock dividends as a replacement for or supplement to
cash dividends. The payment of stock dividends involves a shifting of
funds between capital accounts rather than an outflow of funds. Stock
dividends do not change the market value of stockholders’ holdings,
proportion of ownership, or share of total earnings. Therefore stock
dividends are usually nontaxable. However, stock dividends may
satisfy owners and enable the firm to preserve its market value without
having to use cash.

(cont.)
LG6 Explain stock splits and the firm’s motivation for undertaking
them.
– Stock splits are used to enhance trading activity of a firm’s shares by
lowering or raising their market price. A stock split merely involves
accounting adjustments; it has no effect on the firm’s cash or on its
capital structure and is usually nontaxable.
– Firms can repurchase stock in lieu of paying a cash dividend, to retire
outstanding shares. Reducing the number of outstanding shares
increases earnings per share and the market price per share. Stock
repurchases also defer the tax payments of stockholders.

Chapter Resources on
MyFinanceLab
• Chapter Cases
• Group Exercises
• Critical Thinking Problems

Integrative Case:
O’Grady Apparel Company

Integrative Case:
O’Grady Apparel Company (cont.)

Integrative Case:

Integrative Case:
a. Over the relevant ranges noted in the following table, calculate
the after-tax cost of each source of financing needed to complete
the table.

Integrative Case:
b. (1) Determine the break point associated with common equity.
(2) Using the break points developed in part (1), determine each
of the ranges of total new financing over which the firm’s
weighted average cost of capital (WACC) remains constant. (3)
Calculate the weighted average cost of capital for each range of
total new financing. Draw a graph with the WACC on the vertical
axis and total money raised on the horizontal axis, and show how
the firm’s WACC increases in “steps” as the amount of money
raised increases.

Integrative Case:
c. (1) Sort the investment opportunities described in Table 2 from
highest to lowest return, and plot a line on the graph you drew in
part (3) above showing how much money is required to fund the
investments, starting with the highest return and going to the
lowest. In the words, this line will plot the relationship between
the IRR on the firm’s investments and the total financing required
to undertake those investments. (2) Which, if any, of the available
investments would you recommend that the firm accept? Explain
your answer.

Integrative Case:
d. (1) Assuming that the specific financing costs do not change,
what effect would a shift to a more highly leveraged capital
structure consisting of 50% long-term debt, 10% preferred stock,
and 40% common stock have on your previous findings? (Note:
Rework parts b and c using these capital structure weights.) (2)
Which capital structure—the original one or this one—seems
better? Why?

Integrative Case:
e. (1) What type of dividend policy does the firm appear to
employ? Does it seem appropriate given the firm’s
recent growth in sales and profits and given its current
investment opportunities? (2) Would you recommend
an alternative dividend policy? Explain. How would this
policy affect the investments recommended in part c(2)?

Payout Policy Revised

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Chapter 14

Copyright © 2012 Pearson Prentice Hall.

LG1 Understand cash payout procedures, their tax

LG2 Describe the residual theory of dividends and the key

LG3 Discuss the key factors involved in establishing a

© 2012 Pearson Prentice Hall. All rights reserved. 14-2

LG4 Review and evaluate the three basic types of dividend

LG5 Evaluate stock dividends from accounting,

LG6 Explain stock splits and the firm’s motivation for

© 2012 Pearson Prentice Hall. All rights reserved. 14-3

© 2012 Pearson Prentice Hall. All rights reserved. 14-4

© 2012 Pearson Prentice Hall. All rights reserved. 14-5

P&G’s Dividend History

© 2012 Pearson Prentice Hall. All rights reserved. 14-6

© 2012 Pearson Prentice Hall. All rights reserved. 14-7

Share Repurchases Gain Worldwide Popularity

© 2012 Pearson Prentice Hall. All rights reserved. 14-8

© 2012 Pearson Prentice Hall. All rights reserved. 14-9

© 2012 Pearson Prentice Hall. All rights reserved. 14-10

• The date of record (dividends) is set by the firm’s directors, the

© 2012 Pearson Prentice Hall. All rights reserved. 14-11

© 2012 Pearson Prentice Hall. All rights reserved. 14-12

On June 24, 2010, the board of directors of Best Buy

© 2012 Pearson Prentice Hall. All rights reserved. 14-13

When the dividend was announced by the directors, $63

© 2012 Pearson Prentice Hall. All rights reserved. 14-14

When Best Buy actually paid the dividend on October 26,

© 2012 Pearson Prentice Hall. All rights reserved. 14-15

© 2012 Pearson Prentice Hall. All rights reserved. 14-16

© 2012 Pearson Prentice Hall. All rights reserved. 14-17

© 2012 Pearson Prentice Hall. All rights reserved. 14-18

The Jobs and Growth Tax Relief Reconciliation Act of 2003

© 2012 Pearson Prentice Hall. All rights reserved. 14-19

Capital Gains and Dividend Tax Treatment Extended to 2010

© 2012 Pearson Prentice Hall. All rights reserved. 14-20

The board of directors of Espinoza Industries, Inc., on

© 2012 Pearson Prentice Hall. All rights reserved. 14-21

© 2012 Pearson Prentice Hall. All rights reserved. 14-22

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• What happens to the stock price when a firm pays a

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• The financial literature has reported numerous theories and

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• An investor bought 1000 shares of Microsoft at $ 250 in

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• Assume that Microsoft had declared a dividend of $ 4 per

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The clientele effect is the argument that different payout policies

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Studies have shown that large changes in dividends do affect

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Owners’ investment opportunities:

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