Cfa Level 1 Dividend Policy

Front 1

Optimal dividend policy

Back 1

maximizes share price

Front 2

Dividend irrelevance theory

Back 2

based on modigliani miller assumptions of no tax and transaction costs. Dividend policy has no effect on value of firm as investors can create their own dividends by reinvesting dividends or selling shares

Front 3

Bird-in-the hand theory

Back 3

Dividend policy is relevant as investors prefer dividend (garunteed money now) to capital gains (unexpected return later). This is because dividend yield has less risk than growth

Front 4

Tax preference theory

Back 4

Some investors will prefer cap gains to dividend because..
1. Cap gains are taxed at lower rate than dividends
2. Cap gains can accumulate tax free and are only taxed when realized
3. Cap gains passed on to heirs are not taxed

Front 5

Clientelle effect

Back 5

Different groups of investors may prefer different dividend payout. High tax bracket investors may prefer cap gains. Low tax bracket investors may prefer dividends. Changes in dividend policy only shift investors and do not add to value of firm, therefore, it is wise to have consistant dividend policy

Front 6

Stock repurchases (advantages)

Back 6

1. Investors view repurchase as positive sign
2. repurchase give stockholder choice between selling or holding
3. Large block of stocks may be overhanging in the market keeping price down. This can eliminate overhang
4. Repurchase gives firm flexibility. If excess cash is temporary, repuchase is way to pay dividend without changing div policy and signaling the mkt.
5. Good way to change capital structure

Front 7

Stock repurchases (disadvantages)

Back 7

1. Some stockholders prefer dividends to cap gains
2. Some selling stockholders may not understand implications of repurchase
3. Corporation may overpay for stock

Front 8

Residual dividend model

Back 8

May be helpful in setting long run target payout ratios but should not be used to set dividend policy from year to year because investors prefer predictable dividend payous

Front 9

Residual dividend model (steps)

Back 9

1. Identify optimal cap structure (D/A, D/E ratios)
2. Determine equity needed to finance capital budget under given cap structure
3. Meet equty requiremens to max extent possible with RE
4. Pay dividends with residual (lef over) RE