Dividend Policy

1
Dividend Policy

• May 2, 2007 (LA)
• and May 1, 2007 (OCC)

2
Raising Funds in United States

• Available funds
• Internal funds
• Current shareholders
• Private sources banks, private placements
• Public Sources short-term, long-term
• Securities Acts of 1933 and 1934
• Investment bankers and costs of funds

3
Capital Structure in Practice

• Most firms in the U. S. are mainly equity
  financed despite tax advantage of debt
• Most firm financing is internally generated cash
  in the U. S.
• U.S. firms use less debt (Table 16.4, p. 480)
• Debt markets
• Bank and privately placed debt in Japan, EEC
• Public debt markets and banks in U.S.

4
Dividend Policy

• The dividend decision
• Board of directors deliberation
• Dividends and investment
• Announcement and payment of dividend
• Dividends as a source of cash for investors
• Tax treatment of dividends
• Individuals and other investors
• Combination of corporate and individuals
• Equilibrium in capital markets

5
Summary M-M Debate Issues
6
M-M Dividend Irrelevance

• Assume no taxation and efficient markets
• Stockholders can create cash flows equivalent to
  dividends by selling shares
• Shareholders not needing cash can reinvest
  dividends in stock
• Reinvested earnings (not paid as dividends) grow
  at firms rate of return and produce gains
• New equity dilutes old claims on income

7
Investment and Dividends

• Firms should invest in all NPVgt0 projects
• Investment determines a firms value
• Value of firm (with or without debt) depends on
  the value from investments
• Cash dividends increase need for new equity

8
Dividend Debate

• Taxation issues (past and current)
• Information in dividends
• Cash payment signals real cash flows
• Smoothing implies information on future cash
• Tax effects may be offset
• Clientele effects
• Miller-Scholes strategies can eliminate problem
• Evidence

9
Course Summary and Review

10
Corporate Financial Decisions

• Investments
• Long-term strategic commitments of capital
• Tangible and intangible, projects or companies
• Financing
• Debt or equity
• Term, conditions, commitments
• Working Capital
• Cash
• Inventory and accounts receivable
• Short-term borrowing and accounts payable

11
Corporate Finance Questions

• What determines asset values and how do interest
  rates and expectations affect them?
• Which projects should we invest in?
• Which risks are important for investors?
• How can we measure and adjust for risk?
• Does a firms financing or dividend policy matter?

12
Determinants of Value

• Cash, Time, Risk determine value
• Present value analysis deals with the effect of
  time or timing on value
• Cash flow estimation is the subject of the next
  part of the course (classes 5 to 8)
• Risk is incorporated in the discount rate that we
  discuss in Part 3 of the course
• Positive net present value projects create value
  for investors

13
Required Rates of Return

• Investors require compensation for systematic
  risk
• If expected returns from a project or an asset is
  higher than the required rate, it has positive
  net present value
• Equivalently, its internal rate of return is
  higher than the opportunity rate
• Security market line is relation between
  systematic risk and required rates in CAPM

14
Rigor implies Mathematics

• Multi-period expressions with factors raised to
  powers (present value calculations in Chapter 4)
• Polynomial functions mean non-linear relations
• Sometimes more than one way to solve a problem
• Arithmetic, but in large doses (projections in
  Chapter 7)
• Addition and subtraction, ratios (division) and
  muliplication,
• Many calculations, not difficult calculations
• Statistical concepts like correlation (analysis
  of risk in Chapters 10 and 12)
• Algebra using equations and unknowns (theory of
  capital structure in Chapter 15)

15
Main Analytical Material in Corporate Finance

• Chapters 4 and 5 - Present value and valuation of
  stocks and bonds
• Chapter 7 - Investment project evaluation
• Chapters 9, 10 and 12 - Portfolio theory, CAPM,
  and capital budgeting with risk
• Chapter 13 - Efficient markets
• Chapters 15, 16, and 18 - M-M theories and debate
  on capital structure and dividends

16
Optional Review Materials

• Summary of Finance Principles Every MBA Should
  Know posted on website
• Compilation of Objectives, Important Vocabulary,
  and Wall Street Journal Articles
• Old final and midterm examinations

17
Important WSJ Stories 2007

• Challenges facing auto industry in restructuring
• Increasing role of private-equity firms in
  corporate restructuring, including in GM and
  Chrysler cases
• Private-equity firms going public
• Costs of SOX compliance continues to be a major
  issue
• SEC and press focus on executive compensation

18
GSBA 548, Finance the Future

• First goal prepare students to deal with an
  environment where finance professionals partially
  determine the environment
• Finance is a branch of rhetoric
• The are no right answers but there are coherent
  and persuasive answers
• Second goal induce sympathy for the financial
  view of the world

19
Finance View of the World

• Your personal world
• Return on your investments, including human
  capital
• Approach to personal financial management
• The real world
• Corporate governance goals of policy, relation
  of policy to efficiency
• Dynamism and complexity of financial markets

20
Current Developments in Finance

• Deepening of consumer financial services markets
  similar to deepening of wholesale markets
• Refinement of market allocation of risks and
  returns, making markets more efficient
• Changes in demand and supply of equity and debt
  and issues in valuation of residual and fixed
  claims
• Technology, globalization, deregulation

21
Final Examination

• Open book, open note, 600-830pm
• Calculator, 2 pencil, and pen
• 25 multiple choice and 3 long answer
• 1/3 covers first half of course, 2/3 last half
• Questions from course objectives, important
  vocabulary, end-of-chapter problems, class
  exercises, and group project
• Review sessions with TAs and instructor

22
Likely Questions

• Major material from key chapters not covered
  extensively in midterm examination
• Hardest questions on midterm considered
  straightforward by instructor
• Applications of problem-solving of basic finance
  principles covered extensively in class

23
Good Luck!!

• Teaching assistants and I want you to do well on
  the final and group project
• We are not trying to tell you how to study for
  the final but want to make everything you might
  need available in a convenient format
• We hope to see you in finance classes in the
  future