Different Types of Payouts

• Many companies pay a regular cash dividend.

– Public companies often pay quarterly.
– Sometimes firms will pay an extra cash dividend.
– The extreme case would be a liquidating dividend.
• Companies will often declare stock dividends.
– No cash leaves the firm.
– The firm increases the number of shares outstanding.
• Some companies declare a dividend in kind.
– Wrigley’s Gum sends a box of chewing gum.
• Other companies use stock buybacks.
 Cash Dividend Payment

Cash Dividend - Payment of cash by the firm to its

shareholders.

Record Date – Date on which company determines

existing shareholders.

Ex-Dividend Date - Date that determines whether a

stockholder is entitled to a dividend payment;
anyone holding stock immediately before this date
is entitled to a dividend.
Procedure for Cash Dividend

25 Oct. 2 Nov. 3 Nov. 5 Nov. 7 Dec.

…

Declaration Cum- Ex- Record Payment

Date dividend dividend Date Date
Date Date

Declaration Date: The Board of Directors declares a payment

of dividends.
Cum-Dividend Date: Buyer of stock still receives the dividend.
Ex-Dividend Date: Seller of the stock retains the dividend.
Record Date: The corporation prepares a list of all individuals
believed to be stockholders as of 5 November.
 Question
• The balance sheet for Levy Corp. is shown here in the
market value terms. There are 12,000 shares of stock
outstanding.
Market Value Balance Sheet
Cash $55,000 Equity $465,000
Fixed Assets 410,000
Total $465,000 Total $465,000

• The company has declared a dividend of $1.90 per share.

The stock goes ex-dividend tomorrow. Ignoring the tax
effect, what is the stock selling for today? What will it sell
for tomorrow? What will the balance sheet look like after
the dividends are paid?
 Stock Dividends
• Pay additional shares of stock instead of cash

• Increases the number of outstanding shares

• Small stock dividend

– Less than 20%
– If you own 100 shares and the company declared a 10% stock
dividend, you would receive an additional 10 shares.

• Large stock dividend – more than 20 to 25%

 Stock Splits
• Stock splits – essentially the same as a stock dividend
except it is expressed as a ratio
– For example, a 2 for 1 stock split is the same as a
100% stock dividend.
• Stock price is reduced when the stock splits.
• Common explanation for split is to return price to a
“more desirable trading range.”
 Repurchase of Stock
• Instead of declaring cash dividends, firms can
rid themselves of excess cash through buying
shares of their own stock.

• Recently, share repurchase has become an

important way of distributing earnings to
shareholders.
 Question
• Lee Ann Inc., has declared a $9.50 per share
dividend. Suppose capital gains are not taxed,
but dividend gains are taxed at 15%. New
regulations require taxes to be withheld when
the dividend is paid. Lee Ann sells for $115 per
share, and the stock is about to go ex-
dividend. What do you think ex-dividend price
would be?
 Answer
The aftertax dividend is the pretax dividend times one
minus the tax rate, so:

Aftertax dividend = $9.50(1 – .15) = $8.08

The stock price should drop by the aftertax dividend

amount:

Ex-dividend price = $115 – 8.08 = $106.93

 Stock Repurchase versus Dividend
Consider a firm that wishes to distribute $100,000 to its
shareholders.
Assets Liabilities & Equity
A. Original balance sheet
Cash $150,000 Debt 0
Other Assets 850,000 Equity 1,000,000
Value of Firm 1,000,000 Value of Firm 1,000,000
Shares outstanding= 100,000
Price per share= $1,000,000 /100,000 = $10
 Stock Repurchase versus Dividend

If they distribute the $100,000 as a cash dividend, the

balance sheet will look like this:
Assets Liabilitie s & Equity
B. After $1 per share cash dividend
Cash $50,000 Debt 0
Other Assets 850,000 Equity 900,000
Value of Firm 900,000 Value of Firm 900,000
Shares outstanding = 100,000
Price per share = $900,000/100,000 = $9
 Share Repurchase
• Flexibility for shareholders
• Keeps stock price higher
– Good for insiders who hold stock options
• As an investment of the firm (undervaluation)
• Tax benefits
 Question
Based on previous Question , suppose Levy
has announced it is going to repurchase
$22,800 worth of stock.
i. What effect will this have on the equity of
the firm?
ii. How many shares will be outstanding?
iii. What will be the price per share be after
the repurchase?
iv. Ignoring tax effect, show how the share
repurchase is effectively the same as a cash
dividend?
 Question
• The Mann Company belongs to risk class for which the appropriate
discount rate is 10%. Mann currently has 220,000 outstanding
shares selling at $110 each. The firm is contemplating the
declaration of a $4 dividend at the end of the fiscal year that just
began. Assume there are no taxes on dividends. Answer the
following questions based on the Miller and Modigliani model;
a) What us the price of the stock on the ex-dividend date of the
dividend is declared?
b) What will the price of the stock at the end of the year if the
dividend is not declared?
c) If Mann makes $4.5 million of new investment at the beginning of
the period, earns net income of $1.9 million, and pays the
dividend at the end of the year, how many shares of new stock
must the firm issue to meet its funding needs?
d) Is it realistic to use MM model in the real world to value stock?
Why or why not?
 The Irrelevance of Dividend Policy
• A compelling case can be made that dividend
policy is irrelevant.
• Since investors do not need dividends to
convert shares to cash; they will not pay
higher prices for firms with higher dividends.
• In other words, dividend policy will have no
impact on the value of the firm because
investors can create whatever income stream
they prefer by using homemade dividends.
 Homemade Dividends
• Bianchi Inc. is a $42 stock about to pay a $2 cash dividend.
• Bob Investor owns 80 shares and prefers a $3 dividend.
• Bob’s homemade dividend strategy:
– Sell 2 shares ex-dividend

homemade dividends $3 Dividend

Cash from dividend $160 $240
Cash from selling stock $80 $0
Total Cash $240 $240
Value of Stock Holdings $40 × 78 = $39 × 80 =
$3,120 $3,120
 Dividend Policy Is Irrelevant

• In the above example, Bob Investor began with a

total wealth of $3,360:
$42
$3,360  80 shares 
share
 After a $3 dividend, his total wealth is still $3,360:
$39
$3,360  80 shares   $240
share
 After a $2 dividend and sale of 2 ex-dividend shares, his
total wealth is still $3,360:
$40
$3,360  78 shares   $160  $80
share
 Dividends and Investment Policy
• Firms should never forgo positive NPV projects
to increase a dividend (or to pay a dividend for
the first time).
• Recall that one of the assumptions underlying
the dividend-irrelevance argument is: “The
investment policy of the firm is set ahead of
time and is not altered by changes in dividend
policy.”
 Personal Taxes, Dividends, and Stock
Repurchases
• To get the result that dividend policy is irrelevant, we
needed three assumptions:
– No taxes
– No transactions costs
– No uncertainty
• In Pakistan, cash dividends gains are (currently) taxed
at a maximum rate of 10 percent.
• Since capital gains are currently not taxed.
 Taxes and Dividends
• In the presence of personal taxes:
1. A firm should not issue stock to pay a dividend.
2. Managers have an incentive to seek alternative
uses for funds to reduce dividends.
3. Though personal taxes mitigate against the
payment of dividends, these taxes are not
sufficient to lead firms to eliminate all dividends.
 Real-World Factors Favoring High Dividends
• Desire for Current Income
• Behavioral Finance
– It forces investors to be disciplined.
• Tax Arbitrage
– Investors can create positions in high dividend
yield securities that avoid tax liabilities.
• Agency Costs
– High dividends reduce free cash flow.
 Question
• The market value balance sheet for Outbox
Manufacturing is shown here. Outbox has
declared a stock dividend of 25%. The stock
goes ex-dividend tomorrow (the chronology
for a stock dividend is similar to that for a cash
dividend). There are 20,000 shares of stock
outstanding. What will the ex-dividend be?
Market Value Balance Sheet
Cash $295,000 Debt $180,000
Fixed Assets 540,000 Equity 655,000
Total $835,000 Total $835,000
 Answer
• The stock price is the total market value of equity divided
by the shares outstanding, so:

• P0 = $655,000 equity/20,000 shares = $32.75 per share

• The shares outstanding will increase by 25 percent, so:

• New shares outstanding = 20,000(1.25) = 25,000

• The new stock price is the market value of equity divided

by the new shares outstanding, so:
• PX = $655,000/25,000 shares = $26.20
 Question
• The company with common equity account shown
here has declared a stock dividend of 15% when the
market value of the stock is $45 per share. What effect
on the equity accounts will the distribution of the stock
dividend have?

• Common Stock ($1 par value) $410,000

• Capital Surplus 2,150,000
• Retained Earnings 5,320,000
• Total owner’s equity $7,880,000
 Question
• Roll Corporation (RC) currently has 330,000 shares of
stock outstanding that sell for $64 per share. Assuming
no market imperfections or tax effect exist, what will
the share price be after:
a) RC has a five-for-three stock split?
b) RC has a 15% stock dividend?
c) RC has a 42.5% stock dividend?
d) RC has a four-for-seven reverse stock split?

Determine the new number of shares outstanding in

parts (a) through (d)
 Answer
To find the new stock price, we multiply the current stock
price by the ratio of old shares to new shares, so:

a. $64(3/5) = $38.40

b. $64(1/1.15) = $55.65
To find the new shares outstanding, we multiply the current
shares outstanding times the ratio of new shares to old
shares, so:
a: 330,000(5/3) = 550,000

b: 330,000(1.15) = 379,500
 Quick Quiz

• What are the different types of dividends, and

how is a dividend paid?
• What are stock dividends, and how do they differ
from cash dividends?
• How are share repurchases an alternative to
dividends, and why might investors prefer them?