33:390:400 Lecture Notes - Lecture 5: Dividend Yield, Stock Split, Cash Flow

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11 May 2018

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Chapter 19: Dividends and Other Payouts

Firms will usually always have some free cash flow; need to figure out what to do with it

Q - If they want to return money to shareholders, should it be done by dvd or buyback

Q - How much cash should a firm return to investors vs. holding cash internally

19.1 Different Types of Payouts

A. Dividends – Cash distribution of earnings

- Distribution made from sources other than Retained Earnings

- Regular cash dividend

- Public companies often pay them quarterly

- Sometimes firms will throw in extra cash dividends

- Stock dividend

- No cash leaves the firm (not a true dividend)

- Firm increases the # of shares outstanding → dilution for current shareholders

B. Share Repurchases

- Instead of dividends, firm can get rid of excess cash by buying shares of their own stock

- Shares are held by firm and are called “Treasury Stock”

C. Stock Split

- Increases the number of shares outstanding (increasing the # of shares you own)

- The price drops inversely proportional to the increase in shares

Ex: 2 for 1 stock split; stock price splits in two, but the # of shares doubles

19.2 Standard Method of Cash Dividend Payment

Dividends are not mandatory; it is up to the Board of Directors to decide if a dvd will be paid out

Dividends are usually expressed as dividend per share (dividend yield) or EPS (dividend payout)

The Process of Giving out a Dividend:

1. Declaration Date: January 31st

- The Board of Directors declare a payment of dividends

2. Cum-Dividend Date: February 6th

- The last day that the buyer of a stock is entitled to the dividend

3. Ex-Dividend Date: February 7th

- The first day the seller of a stock is entitled to the dividend

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4. Date of Record: February 9th

- The corporation prepares a list of all individuals believed to be stockholders

4. Date of Payment: March 9th

- The dividend checks are mailed

The person purchasing a stock before the ex-dividend date will receive the dividend

The person purchasing a stock after the ex-dividend date will not receive the dividend

Stock price will fall on the ex-dividend date by the same amount of the dividend

- Proves that the market is efficient; since the stock is losing the value of the dividend

Before ex-dividend date: Price = Price + Dividend

Day of and After ex-dividend date: Price drops by the amount of dvd Price = Price - Dvd

# of companies paying dividends has declined over time; more stock buybacks

19.2 Dividend Policy in a Perfect World

M&M dividend theory

Assume:

- No taxes, no transaction costs, financing and operating activities are fixed

Answer to Q1: Choice of dividends or stock buybacks does not matter

Answer to Q2: Choice of how much cash to keep on hand does not matter

Ex: Two firms; Firm X and Firm Y

Firm X will pay $10,000,000 in dividends next year

Firm Y will repurchase “N” number of shares next year for $10,000,000

Each firm has 1 million s/o

After cash is distributed by the firms they will be identical → same equity values “V”

Firm X’s stock price after the cash is distributed: X1 = V/1,000,000

Firm Y’s stock price after the cash is distributed: Y1 = V/(1,000,000 – N)

(Y1 x N) = 10,000,000

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Document Summary

Q - if they want to return money to shareholders, should it be done by dvd or buyback. Q - how much cash should a firm return to investors vs. holding cash internally. Sometimes firms will throw in extra cash dividends. No cash leaves the firm (not a true dividend) Firm increases the # of shares outstanding dilution for current shareholders. Distribution made from sources other than retained earnings. Firms will usually always have some free cash flow; need to figure out what to do with it. 19. 1 different types of payouts: dividends cash distribution of earnings, share repurchases, stock split. Dividends are not mandatory; it is up to the board of directors to decide if a dvd will be paid out. Dividends are usually expressed as dividend per share (dividend yield) or eps (dividend payout) Increases the number of shares outstanding (increasing the # of shares you own)

Related Questions

Which one of the following statements about common stock is correct?

A. Firms tend to repurchase shares of their outstanding stock when they view the shares as undervalued.

B. Treasury stock is a means of increasing the number of shares outstanding.

C. Transaction costs cannot be expected to significantly reduce the rate of return on stock investments.

D. Common stock gives stockholders first title to a share of the company's earnings, prior to other corporate obligations.

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Tiffany owned 1000 shares of GIA stock which was selling for $1.50 per share when the company declared a 1 for 10 reverse split. After the split, Tiffany owned

A. 10,000 shares worth approximately $1.50 per share.

B. 10,000 shares worth approximately $0.15 per share.

C. 100 shares worth approximately $15 per share.

D. 100 shares worth approximately $1.50 per share.

----

Westlake Industries has total assets of $42.5 million, total debt of $29.3 million, and $2.4 million of 6% preferred stock outstanding. If the company has 250,000 shares of common stock outstanding, its book value per share would be

A. $32.33.

B. $33.60.

C. $43.20.

D. $52.80.

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The Limberger Corporation declared a quarterly dividend of $0.10 per share. The ex-dividend date was July 15, the date of record was July 18, and the payment date was July 28. If you had owned 100 shares of the Limberger Corporation and sold them on July 15, then

A. you would collect $10.00 in dividends, and the purchaser would not collect any dividends.

B. the purchaser would collect $10.00 in dividends, and you would not collect any dividends.

C. you would collect $5.00 in dividends, and the purchaser would collect $5.00 in dividends.

D. neither you nor the purchaser would collect any money in dividends.

----

Pilgrim Corp. stock currently sells for $25 per share? The dividend yield is $1.00 per share and earnings per share are $3.00. The dividend yield is ________ and the the dividend payout ratio is ________.

A. 12%, .48%

B. 8.33%, 25%

C. 4%, 33%

D. 33%,4%.

----

A high current ratio can tell us that the company ________.

A. should be able to cover the current liabilities

B. should be able to keep away from short-term cash problems

C. may have too much capital tied up in current assets

D. All of the above

E. Only A and B

----

Which of these statements is true?

A. For a company to remain in business for the long term, cash flow from investing activities and financing activities must generally be positive numbers.

B. A company may appear to be profitable on its income statement, but fail to generate strong cash flows.

C. The statement of cash flows is used to assess a company's long-term solvency.

D. The income statement reflects the amount of cash available for investment and financing activities.

----

A company has sales of $640,000, net profit after taxes of $23,000, and a total asset turnover of 2.5. What is the return on assets?

A. 3.6%

B. 4.5%

C. 8.1%

D. 9.0%

----

The Merry Co. has current annual sales of $350,000 and a net profit margin of 6%. Sales are expected to increase by 5% annually while the profit margin is expected to remain constant. What is the projected after-tax earnings for two years from now?

A. $19,294
B. $22,050
C. $23,100
D. $23,153 ----

magentawalrus483

Electronic Timing, Inc. (ETI) is a small company founded 15 years ago by electronic engineers Tom Miller and Jessica Kerr. ETI manufactures integrated circuits to capitalize on the complex mixed signal design technology and has recently entered the market for frequency timing generators, or silicon timing devices, which provide the timing signal or ï¿½clocksï¿½ necessary synchronize electronic systems. Its clock products originally were used in PC video graphics applications, but the market subsequently expanded to include motherboards, PC peripherals devices, and other digital consumer electronics, such as digital television boxes and game consoles. ETI also designs and markets custom application-specific integrated circuits (ASICs) for industrial customers. The ASICï¿½s design combines analog and digital, or mixed signal, technology. In addition to Ton and Jessica, Nolan Pittman, who provided capital for the company, is the third primary owner. Each owns 25 percent of the one million shares outstanding. The company has several other individuals, including current employees, who own the remaining shares. Recently, the company designed a new computer motherboard, The Companyï¿½s design is both more efficient and less expensive to manufacture, and the ETI design is expected to become standard in many personal computers. After investigating the possibility of manufacturing the new motherboard, ETI determined that the cost involved in building a new plant would be prohibitive. The owners also decided that they were unwilling to bring in another large outside owner. Instead, ETI sold the design to an outside firm. The sale of the motherboard design was completed for an after-tax payment of $30 million.

Please answer all 6 questions:

1. Tom believes the company should use the extra cash to pay a special one-time dividend. How will this proposal affect the stock price and company value?

2.Jessica believes that the company should use the extra cash to pay off debt and upgrade and expand its existing manufacturing capability. How would Jessica's proposal affect the company?

3) Nolan is in favor of a share repurchase. He argues that a repurchase will increase the company's P/E ratio, return on assets, and return on equity. How will a share repurchase affect the value of the company?

4. Another company option discussed by Tom, Jessica, and Nolan would be to begin a regular dividend payment to shareholders. How would you evaluate this proposal?

5. One way to value a share of stock is the dividend growth, or growth perpetuity, model. Consider the following: The dividend payout ratio is one minus b, where b is the retention or plowback ratio. So the dividend next year will be earning next year, E1, times one minus the retention ratio. The most commonly used equation to calculate the sustainable growth is the return on equity times the retention ratio. Substituting these relationships into the dividend growth model, we can get the equation to calculate the price of a share today. Explain what are the implications of this result in terms of whether the company should pay a dividend or upgrade and expand it manufacturing capability?

6.Does the question of whether the company should pay a dividend depend on whether the company is organized as a corporation or an LLC?

carminehound337

Case 19: Determining the Cost of Capital

The Oceanic Corporation, a Chesapeake, VA based company, was established in 1994. Glenn Rodgers III founded the corporation, which was privately owned at the time, after his retirement from Norentech Corporation. The Oceanic Corporation was originally formed to provide ship repair services and quickly earned a Department of Defense (DOD) certified Alteration Boat Repair (ABR) designation. Among its specialties were structural welding, piping system installation and repairs, electrical, painting, rigging, machinery and dry-dock work, as well as custom sheet metal fabrication. Other divisions of The Oceanic included Habitability Installation, Industrial Contracting, and Alteration/Installation Teams (AIT). With its initial success and good return on investment the firm opened and operated facilities in California, New Jersey, Florida, Maryland, Pennsylvania and Washington.

In 1998, the company went public and its initial public offering was very successful. The stock price had risen from its initial value of $10 to its current level of $35 per share. There were currently 5 million shares outstanding. In 1999, the company issued 30-year bonds at par, with a face value of $1000 and a coupon rate of 10% per year, and managed to raise $40 million for expansion. Currently, the AA-rated bonds had 25 years left until maturity and were being quoted at 91.5% of par.

Over the past year, The Oceanic Corporation utilized a new method for fabricating composite materials that the firmï¿½s engineers had developed. In June of last year, management established the Advanced Materials Group (AM Group), which was dedicated to pursuing this technology. The firm recruited Larry Stone, a senior engineer, to head the AM Group. Larry also had an MBA from a prestigious university under his belt. Upon joining Oceanic, Larry realized that most projects were being approved on a ï¿½gut feelï¿½ approach. There were no formal acceptance criteria in place. Up until then, the company had been lucky in that most of its projects had been well selected and it had benefited from good relationships with clients and suppliers. ï¿½This has to change,ï¿½ said Larry to his assistant Stephanie, ï¿½we canï¿½t possibly be this lucky forever. We need to calculate the firmï¿½s hurdle rate and use it in future.ï¿½

Stephanie Phillips, who had great admiration for her boss, replied, ï¿½Yes, Larry, why donï¿½t I crunch out the numbers and give them to you within the next couple of days?ï¿½ ï¿½That sounds great, Stephanie,ï¿½ said Larry. ï¿½My years of experience tell me that when it comes to the hurdle rate for new projects, one size hardly ever fits all!ï¿½

As Stephanie began looking at the financial statements, she realized that she was going to have to make some assumptions. First, she assumed that new debt would cost about the same as the yield on outstanding debt and would have the same rating. Second, she assumed that the firm would continue raising capital for future projects by using the same target proportions as determined by the book values of debt and equity (see Table 1 for recent balance sheet). Third, she assumed that the equity beta (1.5) would be the same for all the divisions. Fourth, she assumed that the growth rates of earnings and dividends would continue at their historical rate (see Table 2 for earnings and dividend history). Fifth, she assumed that the corporate tax rate would be 34%, and finally, she assumed that the flotation cost for debt would be 5% of the issue

price and that for equity would be 10% of selling price. The 1-year Treasury bill yield was 4% and the expected rate of return on the market portfolio was 10%.

Table 1

The Oceanic Corporation

Balance Sheet

('000s)

Cash 5000

Accounts Receivables 10000

Inventory 20000

Total Current Assets 35000

Land & Buildings (net) 43000

Plant and Equipment (net) 45000

Total Fixed Assets 88000

Total Assets 123000

Accounts Payable 8000

Accruals 5000

Notes Payable 10000

Total Current Liabilities 23000

Long-term debt 40000

Retained Earnings 10000

Common stock

(5 million shares outstanding) 50000

Total liabilities and shareholders' equity 123000

Table 2

The Oceanic Corporation

Sales, Earnings, and Dividend History

('000s)

Year Sales Earnings per Share Dividends per Share

1998 $24,000,000 $ 0.48 $ 0.10

1999 28,800,000 0.58 0.12

2000 36,000,000 0.72 0.15

2001 45,000,000 0.86 0.18

2002 51,750,000 0.96 0.20

2003 62,100,000 1.06 0.22

2004 74,520,000 1.20 0.25

8. How should Stephanie calculate the firmï¿½s hurdle rate or WACC? Calculate it and explain the various steps.

lemonalligator154

33:390:400 Lecture Notes - Lecture 5: Dividend Yield, Stock Split, Cash Flow

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