Distribution To Shareholders Dividends And Shares Repurchase CBA

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A. Dividend and capital gain

the dividends and the capital gain to maximize the stock price.

2. Target Dividend payout ratio is the target percentage of the net income that

will paid as dividends.

3. The optimal dividend policy is one that makes balance between current

dividend and future growth to maximize the stock price.

4. Increase in dividends will increase D1 and increase the stock price. Increase in

dividend will decrease the growth and decrease the stock price. So, there are

two opposite effect.

5. Dividend irrelevant theory.MM advanced the theory that the divided do not

affect the price per share or the WACC of the firm. They suggested that the firm

will be affected by the BEP or the income generated from asset.

6. The theory assumed that the firm pays no tax, investors and managers have the

same information and the selling and buying stocks has no transaction cost.

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7. Why some investors prefer dividends. MM theory suggested that investors

prefer sure dividends today than uncertain capital gain. Retiree prefer to more

dividends because dividends considered their important income.

8. Why some investors prefer capital gain. Capital gain has tax advantage on

dividend because tax is paid at the time of sale.

B. Other dividends policy

managers provide to the investors about how the management see the firms.

2. Dividends announcement will have information content or signal effect about

future earnings.

3. Clientele effect. Clientele is a different group of the stockholders that prefer

different dividend policy. The clientele effect is the tendency of the firm to

attract the investors who prefer its dividend policy.

C. How the company determine the value of dividends.

must consider two points. First the objective to maximize stock holder’s value.

Second the cash flows suitable to shareholders.

2. So, management not retains income unless they can reinvest it at high rate of

return.

3. Some firm like profitable and mature firms has large amount of cash and less

investment opportunities. Those firm will distribute high dividends and attract

a clientele who prefer more dividends (vice versa)

4. The optimal payout ratio is function of management opinion about investors,

investment opportunities, target capital structure and the cost of external

common equity.

5. Residual dividends model is a model assume that the dividends equal the net

income minus the amount of retained earning necessary to finance the optimal

capital budget.

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6. In residual dividends model. Company first determine the optimal capital

budget, second determine the capital structures, third determine the amount

of retained earning needed to finance and finally fourth distribute the residual

value of net income.

7. The residual dividend policy make lead to unstable dividend.

8. Earnings and cash flows are important when determine the dividends. cash

flow per share and earnings per share are closely related.

D. Payment procedures
1. Declaration date is the date where the board of directors declares the

number of dividends. After declaration the dividends became current

liabilities in the company balance sheet.

2. Holder of record date the date where the company recorded dividends to the

shares.

3. Ex- dividends date is two business days before the date of record. If someone

purchases the stock within the ex-dividends date, he will not take a dividend.

4. Payment date is the date where the company mailed the checks to the

holders of record.

E. Dividend reinvestment plans

reinvestment their dividends in the company. It is a plan that using to buy

new stock or outstanding stocks.

2. In dividends reinvestment plan the stockholders may choose to receive

dividends or purchase the stock.

3. The dividends reinvestment plan is decrease the transaction cost of the

buyers of the stocks.

4. In a new stock DRIPs the company offers the stocks with discount because

the flotation cost decreased. No fees charged to the stock holders

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F. Factors influencing the dividends policy.

1. Constrain like debt that will decrease the dividends. Constrain like

preferred stock, dividends to common stocks cannot be paid until paying

the preferred stock dividends.

2. Constrain like impairment of capital rule, the rule stated that the firm

cannot pay a dividend more than the stated retained earnings in balance

sheet.

3. Constraint like availability of cash and penalty of tax on improperly

accumulated cash and don’t distribute earnings.

2) Investment opportunities. Number of investment opportunities and the

availability of delaying and accelerating investments.

3) Alternatives source of capital.

1. High cost of external equity decreases the dividends because the firm will

depend on the retained earnings on financing.

2. Ability to substitute the debt to equity. If the firm can change the debt ratio

without increasing WACC it can pay a dividend by increasing debt.

3. Control. if the management need to retain control it may not issuing new

stocks and depend on the retained earnings.

4) Effect of dividends policy on rs. Change in dividends will affect the capital

gain and affect the risk so will affect the rs.

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G. Stocks dividends and stock splits

1. Stock split. Is an action by the firm that increase the number of the shares

outstanding by doubling or tripling the numbers of shares and decrease the

price.

2. Stock dividends .is a dividend pay to stock holders on the basis of stocks

instead of cash.

3. Reverse split will reduce the number of shares outstanding.

H. Stock repurchase or treasury stocks

1) Stock repurchase (treasury stock) is an action by the firm that buybacks its

stock to decreasing the number of shares, increase stock price and increase

the earning per share.

2) Stock repurchase may be for distribute dividends by repurchase rather than

paying a cash in order to increase stock price, or may the capital structure

have of high percentage of equity or may be repurchased by the company to

give stocks to employee as stock option exercised instead of issuing new

stocks.

3) Repurchased announcement May send a good signal to the stock holders and

may rising the stock price. Stockholders have choice to take cash dividends or

repurchase stocks. Repurchase can be used to change the capital structure.

4) Repurchase has a tax advantage than the cash dividends through the differed

tax on capital gain.

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Distribution To Shareholders Dividends And Shares Repurchase CBA
I. Important rules
1. Net income = div + retained earning

2. Equity capital needed = capital budget ×equity %

3. If equity need> net income then equity need = retained earning

4. Div = net income -retained earning

5. If equity need ≥ net income then all net income is retained earnings and div =

zero

6. The payout ratio = (div / net income)

7. Retained earning = net income - div

Problem

15-1

RESIDUAL DIVIDEND MODEL: Axel Telecommunications has a target capital

structure that consists of 70% debt and 30% equity. The company anticipates that

its capital budget for the upcoming year will be $3,000,000. If Axel reports net

income of $2,000,000 and it follows a residual dividend payout policy, what will be

its dividend payout ratio?

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15-2

STOCK SPLIT: Gamma Medical’s stock trades at $90 a share. The company is
contemplating a 3-for-2 stock split. Assuming that the stock split will have no
effect on the market value of its equity, what will be the company’s stock price
following the stock split?

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15-3

STOCK REPURCHASES: Beta Industries has net income of $2,000,000, and it has
1,000,000 shares of common stock outstanding. The company’s stock currently
trades at $32 a share. Beta is considering a plan in which it will use available
cash to repurchase 20% of its shares in the open market. The repurchase is
expected to have no effect on net income or the company’s P/E ratio. What will be
Beta’s stock price following the stock repurchase?

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15-4

STOCK SPLIT: After a 5-for-1 stock split, Strasburg Company paid a dividend of
$0.75 per new share, which represents a 9% increase over last year’s pre-split
dividend. What was last year’s dividend per share?

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15-5

EXTERNAL EQUITY FINANCING: Northern Pacific Heating and Cooling Inc. has a 6-
month backlog of orders for its patented solar heating system. To meet this
demand, management Chapter 15 Distributions to Shareholders: Dividends and
Share Repurchases 481 plans to expand production capacity by 40% with a $10
million investment in plant and machinery. The firm wants to maintain a 40% debt-
to-total-assets ratio in its capital structure. It also wants to maintain its past
dividend policy of distributing 45% of last year’s net income. In 2008, net income
was $5 million. How much external equity must Northern Pacific seek at the
beginning of 2009 to expand capacity as desired? Assume that the firm uses only
debt and common equity in its capital structure.

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15-6

RESIDUAL DIVIDEND MODEL:

Welch Company is considering three independent projects, each of which requires

Project H (high risk): Cost of capital = 16% IRR =20%

Project M (medium risk): Cost of capital = 12% IRR =10%

Project L (low risk): Cost of capital = 8% IRR= 9%

Note that the projects’ costs of capital vary because the projects have different
levels of risk. The company’s optimal capital structure calls for 50% debt and 50%
common equity. Welch expects to have net income of $7,287,500. If Welch
establishes its dividends from the residual model, what will be its payout ratio?

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