Intro to Financial Management

1
Intro to Financial Management

• Dividend Policy

2
Review

• Homework
• Income stream risks
• Business risks
• Operating risk
• Break-even analysis
• Operating leverage
• Capital structure
• Leverage
• Coverage ratio
• Match maturity of financing with maturity of
  asset

3
Dividend Policy

• Dividend payout ratio
• dividend per share / earnings per share
• Tradeoff between
• Dividends and future growth
• Dividends and external financing

4
Dividend Policy and Stock Price

• Three views
• No effect
• High dividend will increase the stock price
• Reason less risk to investor
• Low dividend will increase the stock price
• Reason investors can defer taxes

5
Dividend Payment Theories

• Residual Dividend Theory
• Pay dividend only if no more investments to make
  with the cash
• Clientele Effect
• Those who want dividends, will invest in dividend
  paying stocks
• Those that dont, wont
• Information Effect
• Dividend payout changes can signal information
  from the firm
• Agency Costs
• Costs, such as reduced stock price, due to agency
  conflict
• Dividends may reduce these costs
• Expectations Theory
• Market reacts as reality changes relative to
  their expectations

6
Dividends in Practice

• Legal restrictions
• E.g. must have assets gt liabilities
• Liquidity constraints
• May not have the cash
• Earnings predictability
• Future years may not have as good cash flows
• Maintaining Ownership Control
• May retain earnings so do not have to issue new
  stock

7
Dividend Policies

• Constant dividend payout ratio
• Percent of earning paid is constant
• Dollar amount will not be
• Stable dollar dividend
• Relatively stable (constant) payout
• Will change only when management thinks
  appropriate
• Small regular dividend plus year-end extra
• One-time dividend payout

8
Stock Dividend and Stock Splits

• Stock dividend
• Distribution of shares proportionate to current
  holding
• Stock split
• Exchange current shares for new, more shares
• Same effect, different accounting
• Why?
• Optimal trading range, perhaps
• Signal information, perhaps

9
Stock Repurchases

• When firm buys back its stock from the market
• Why?
• Reduces shares on the market
• Increases EPS, ROE
• Increases leverage
• Reduces costs of small (e.g. fractional)
  shareholders
• Result, higher stock price
• What should a firm do with excess cash?Give
  dividends or repurchase shares?
• Want long-term gain or cash now?
• Theoretically, owners should not care
• Note that Apple is doing both