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Homemade Dividends.doc

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York University
Administrative Studies
ADMS 3510
Rebecca Jubis

Homemade Dividends The idea is that in a perfect world (no market imperfections or differential tax rates or transaction costs), you can “undo” any dividend policy of the firm. If a firm says they will pay dividends of $0.60 after one year, and a liquidating dividend of $30 after two years but you want equal dividends in both years, here is how you do it. The firm will give you $0.60 next year and $30 in 2 years. The PV of these cash flows (discounted at 15%) is: 2 PV = $0.60/1.15 + $30/1.15 = $23,206.05 You want equal dividends. Lets call them “D”. Plug them in and solve for the dividend: 2 $23,206.05 = D/1.15 + D/1.15 ; D = $14,274.42 [Some folks have trouble with the math here. If you are comfortable solving for “D” skip this section.] $23,206.05 = D/1.15 + D/1.15 2 Multiply both sides by 1.15 2 2 (1.15 )(23,206.05) = 1.15 D + D 30,690.00 = 2.15 D D = 30,690/2.15 D = $14,274.42 So, now we know what we want. We want $14,274.42 in year 1, but you will only get $600. (You have 1,000 shares and each share gets a 0.60 dividend.) So, sell some shares to make up the shortfall. The only tricky thing is t
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