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21 Cards in this Set
- Front
- Back
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What is "distribution policy?"
Ch. 14 |
The distribution policy defines...
1. Level of cash distributions to shareholders 2. Form of distribution (dividend vs. stock repurchase) 3. Stability of the distribution |
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What are the three dividend policies in relation to whether investors prefer high or low payouts?
Ch. 14 |
1. Dividends are irrelevant: investors do not care about payouts
2. Dividend preference, or bird-in-the-hand: Investors prefer a high payout 3. Tax effect: Investors prefer a low payout |
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What is the dividend irrelevance theory?
Ch. 14 |
Investors are indifferent between dividends and retention-generate capital gains. If they want cash, they can sell stock. If they don't want cash, they can use dividends to buy stock.
Implies the payout policy has no effect on stock value of the required return on stock. Theory is based on unrealistic assumptions. |
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What is the dividend preference (bird-in-the-hand) theory?
Ch. 14 |
Investors might think dividends are less risky than potential future gains. Also, high payouts help reduce agency costs by depriving managers of cash to waste and causing mangers to have more scrutiny by going to the external capital markets more option.
Therefore, investors would value high payouts more highly and would require lower return to induce them to buy stock of a high-payout firm. |
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What is the tax effect theory?
Ch. 14 |
Low payouts mean higher capital gains. Capital gains taxes are deferred until they are realized, sot hey are taxed at a lower effective rate than dividends.
This could cause investors to require a higher pre-tax return to induce them to buy a high payout stock, which would result in a lower stock price. |
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What is the "clientele effect?"
Ch. 14 |
Different groups of investors, or clientele, prefer different dividend policies.
Firm's past dividend policy determines its current clientele of investors. Clientele effects impede changing dividend policy. Taxes & brokerage costs hurt investors who have to switch companies due to a change in payout policy. |
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What is the "information content," or "signaling," hypothesis?
Ch. 14 |
Investors view dividend changes as signals of management's view of the future. Managers hate to cut dividends, so they will not raise dividends unless they think the increase is sustainable.
Therefore, a stock price increase at time of a dividend increase could reflect higher expectations for future EPS, not a desire for dividends. |
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What is the "residual distribution model?"
Ch. 14 |
1. Find the reinvested earnings needed for the capital budget.
2. Pay out any leftover earnings (the residual) as either dividends or stock repurchases. This policy minimizes flotation and equity signaling costs, hence minimizing the WACC. |
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What are the advantages and disadvantages of the residual distribution model?
Ch. 14 |
Advantages:
1. Minimizes new stock issues and flotation costs Disadvantages: 1. Results in variable dividends, sends conflicting signals, increases risk, and doesn't appeal to any specific clientele Conclusion: Consider residual policy when setting target payout but do not follow it rigidly. |
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What is a stock repurchase?
Ch. 14 |
The buying of own company stock back from stockholders.
A stock repurchase has no effect on stock price. Firm announces its intent to repurchase stock, but does not have to complete its announced intent to repurchase. |
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What do stock repurchases occur?
Ch. 14 |
1. As an alternative to distributing cash as dividends
2. To dispose of one-time cash from an asset sale 3. To make a large capital structure change 4. To use when employees exercise stock options |
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What are the three ways to repurchase stock?
Ch. 14 |
1. Have a broker/trustee purchase on open market over a period of time
2. Make a tender offer to shareholders 3. Make a block (targeted) repurchase |
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Why doesn't a stock repurchase affect the stock price?
Ch. 14 |
1. If investors thought that the repurchase would increase the stock price, they would all purchase stock the day before, which would drive up its price.
2. If investors thought that the repurchase would decrease the stock price, they would all sell the stock the day before, which would drive down its price. |
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What are the different results between a stock repurchase and a stock dividend?
Ch. 14 |
In a repurchase, the stock price doesn't fall, yet the number of shares do.
In a dividend distribution, the stock price falls by the amount of the dividend at the time of payment, yet the number of shares doesn't change. |
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What are the advantages and disadvantages of stock repurchases?
Ch. 14 |
Advantages:
1. Stockholders choose to sell or not 2. Helps avoid setting a high, unmaintainable dividend 3. Income received = capital gains, not higher-taxed dividends 4. Stockholders may think stock is undervalued Disadvantages: 1. May be viewed as a negative signal 2. IRS could impose penalties, it it were done to avoid taxes on dividends |
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What is the process of setting a dividend policy?
Ch. 14 |
1. Forecast capital needs over a planning horizon (5 yrs)
2. Set a target capital structure 3. Estimate annual equity needs 4. Set target payout based on residual model 5. Maintain target growth rate if possible, varying capital structure somewhat if necessary |
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What is a stock split?
Ch. 14 |
Firm issues new shares in lieu of paying a cash dividend. Sometimes done to get in "optimal price range" ($20 - $80)
Increases number of shares outstanding. Stock price falls to keep investor's wealth unchanged. |
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What is a stock split?
Ch. 14 |
Firm increases the number of shares outstanding by sending shareholders more shares. For example, by 2:1. Sometimes done to get in "optimal price range" ($20 - $80).
Stock price falls to keep investor's wealth unchanged. |
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What is a dividend reinvestment plan (DRIP)?
Ch. 14 |
Shareholders can automatically reinvest their dividends in shares of the company's common stock. Get more stock than cash.
Two types of plans: Open market New stock |
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What is an open market purchase plan?
Ch. 14 |
Dollars to be reinvested are turned over to trustee, who buys shares on the open market.
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What is a new stock plan?
Ch. 14 |
Firm issues new stock to DRIP enrollees, keeps money and uses it to buy assets.
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