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Asw
ath Dam
odaran127
Returning C
ash to the Ow
ners:D
ividend Policy
Asw
ath Dam
odaran
Asw
ath Dam
odaran128
First P
rinciples
Invest in projects that yield a return greater than the minim
umacceptable hurdle rate.•
The hurdle rate should be higher for riskier projects and reflect the
financing mix used - ow
ners’ funds (equity) or borrowed m
oney (debt)
•R
eturns on projects should be measured based on cash flow
s generatedand the tim
ing of these cash flows; they should also consider both positive
and negative side effects of these projects.
Choose a financing m
ix that minim
izes the hurdle rate and matches the
assets being financed.
If there are not enough investments that earn the hurdle rate,
return the cash to stockholders.•
The form
of returns - dividends and stock buybacks - will depend
upon the stockholders’ characteristics.
Objective: M
aximize the V
alue of the Firm
Asw
ath Dam
odaran129
Dividends are sticky
Dividend C
hanges : 1989-1998
0.00%
10.00%
20.00%
30.00%
40.00%
50.00%
60.00%
19891990
19911992
19931994
19951996
19971998
Year
% of all firms
Increasing dividendsD
ecreasing dividendsN
ot changing dividends
Asw
ath Dam
odaran130
Dividends tend to follow
earnings
Figure 21.5: D
ividends and Earnings at U
S F
irms: 1960 - 1998
0.0
0
5.0
0
10
.00
15
.00
20
.00
25
.00
30
.00
35
.00
40
.00
45
.00
1960
1961
1962
1963
1964
1965
1966
1967
1968
1969
1970
1971
1972
1973
1974
1975
1976
1977
1978
1979
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
Year
$ Dividends/Earnings
Earnings
Dividends
Asw
ath Dam
odaran131
More and m
ore firms are buying back stock,
rather than pay dividends...
Fig
ure
2
2.1
: S
toc
k
Bu
yb
ac
ks
a
nd
D
ivid
en
ds
: A
gg
reg
ate
fo
r U
S
Firm
s
- 1
98
9-9
8
$-
$5
0,0
00
.00
$1
00
,00
0.0
0
$1
50
,00
0.0
0
$2
00
,00
0.0
0
$2
50
,00
0.0
0
19
88
19
89
19
90
19
91
19
92
19
93
19
94
19
95
19
96
19
97
19
98
Ye
ar
Stock B
uybacksD
ivide
nd
s
Asw
ath Dam
odaran132
Measures of D
ividend Policy
Dividend Payout:
• m
easures the percentage of earnings that the company pays in dividends
•=
Dividends / E
arnings
Dividend Y
ield:
•m
easures the return that an investor can make from
dividends alone
•=
Dividends / Stock Price
Asw
ath Dam
odaran133
Dividend P
ayout Ratios: January 2002
0
20
40
60
80
100
120
140
160
180
0-5%
5-10%
10-15%
15-20%
20-25%
25-30%
30-35%
35-40%
40-45%
45-50%
50-60%
60-70%
70-80%
80-90%
90-100%
>100%
Div
iden
d P
ayo
ut R
atio
s: Jan
uary
20
02
Firm
s paying/not paying dividends
0
500
1000
1500
2000
2500
Pay divid
ends
Pay no d
ividen
ds
Number of firms
Asw
ath Dam
odaran134
Dividend Y
ields in the United S
tates: January2002
0
50
100
150
200
2500-0.25%
0.25-0.5%0.5-0.75%
0.75-%
1-1.25%
1-1.5%1.5-1.75%
1.75-2%
2-2.5%
2.5-3%
3-3.5%
3.5-4%
4-5%
>5%
Div
iden
d Y
ield
s: Jan
uary
20
02
Num
ber o
f divid
end Payin
g firm
s = 1
800
Num
ber o
f non-d
ividen
d Payin
g firm
s = 3
971
Asw
ath Dam
odaran135
Three S
chools Of T
hought On D
ividends
1. If •
(a) there are no tax disadvantages associated with dividends
•(b) com
panies can issue stock, at no cost, to raise equity, whenever
needed
•D
ividends do not matter, and dividend policy does not affect value.
2. If dividends have a tax disadvantage,
•D
ividends are bad, and increasing dividends will reduce value
3. If stockholders like dividends, or dividends operate as a signal of future prospects,
•D
ividends are good, and increasing dividends will increase value
Asw
ath Dam
odaran136
The balanced view
point
If a company has excess cash, and few
good projects (NPV
>0),
returning money to stockholders (dividends or stock repurchases) is
GO
OD
.
If a company does not have excess cash, and/or has several good
projects (NPV
>0), returning m
oney to stockholders (dividends orstock repurchases) is B
AD
.
Asw
ath Dam
odaran137
Why do firm
s pay dividends?
The M
iller-Modigliani H
ypothesis: Dividends do not affect value
Basis:•
If a firm's investm
ent policy (and hence cash flows) don't change, the
value of the firm cannot change w
ith dividend policy. If we ignore
personal taxes, investors have to be indifferent to receiving eitherdividends or capital gains.
Underlying A
ssumptions:
•(a) T
here are no tax differences between dividends and capital gains.
•(b) If com
panies pay too much in cash, they can issue new
stock, with no
flotation costs or signaling consequences, to replace this cash.
•(c) If com
panies pay too little in dividends, they do not use the excesscash for bad projects or acquisitions.
Asw
ath Dam
odaran138
The T
ax Response: D
ividends are taxed more
than capital gains
Basis:•
Dividends are taxed m
ore heavily than capital gains. A stockholder w
illtherefore prefer to receive capital gains over dividends.
Evidence:•
Exam
ining ex-dividend dates should provide us with som
e evidence onw
hether dividends are perfect substitutes for capital gains.
Asw
ath Dam
odaran139
Price B
ehavior on Ex-D
ividend Date
Let P
b = Price before the stock goes ex-dividend
Pa =
Price after the stock goes ex-dividend D
= D
ividends declared on stock to , tcg =
Taxes paid on ordinary incom
e and capital gains respectively
$ Pb$Pa
______________|_______ Ex-Dividend Day _______________|
Asw
ath Dam
odaran140
Cashflow
s from S
elling around Ex-D
ividendD
ay
The cash flow
s from selling before then are-
Pb - (P
b - P) tcgT
he cash flows from
selling after the ex-dividend day are-P
a - (Pa - P) tcg +
D(1-to )
Since the average investor should be indifferent between selling before
the ex-dividend day and selling after the ex-dividend day -P
b - (Pb - P) tcg =
Pa - (P
a - P) tcg + D
(1-to )M
oving the variables around, we arrive at the follow
ing:
Asw
ath Dam
odaran141
Price C
hange, Dividends and T
ax Rates
IfP
b - Pa =
Dthen
to = tcg
Pb - P
a < D
then to >
tcgP
b - Pa >
Dthen
to < tcg
Pb−
Pa
D =
(1
-to )
(1−
tcg )
Asw
ath Dam
odaran142
The E
vidence on Ex-D
ividend Day B
ehavior
OrdinaryInco
meCapital
Gains(
Pb-
Pa )/D
Before1981
70%
28%
0.78(1966-69)
1981-8550
%20
%0.85
1986-199028
%28
%0.90
1991-199333
%28
%0.92
1994..39.6
%28
%0.90
Asw
ath Dam
odaran143
Dividend A
rbitrage
Assum
e that you are a tax exempt investor, and that you know
that theprice drop on the ex-dividend day is only 90%
of the dividend. How
would you exploit this differential?
Invest in the stock for the long term
Sell short the day before the ex-dividend day, buy on the ex-dividendday
Buy just before the ex-dividend day, and sell after.
______________________________________________
Asw
ath Dam
odaran144
Exam
ple of dividend capture strategy with tax
factors
XY
Z com
pany is selling for $50 at close of trading May 3. O
n May 4,
XY
Z goes ex-dividend; the dividend am
ount is $1. The price drop
(from past exam
ination of the data) is only 90% of the dividend
amount.
The transactions needed by a tax-exem
pt U.S. pension fund for the
arbitrage are as follows:
•1. B
uy 1 million shares of X
YZ
stock cum-dividend at $50/share.
•2. W
ait till stock goes ex-dividend; Sell stock for $49.10/share (50 - 1*0.90)
•3. C
ollect dividend on stock.
Net profit =
- 50 million +
49.10 million +
1 million =
$0.10 million
Asw
ath Dam
odaran145
The w
rong reasons for paying dividendsT
he bird in the hand fallacy
Argum
ent: Dividends now
are more certain than capital gains later.
Hence dividends are m
ore valuable than capital gains.
Counter: T
he appropriate comparison should be betw
een dividendstoday and price appreciation today. (T
he stock price drops on the ex-dividend day.)
Asw
ath Dam
odaran146
The excess cash hypothesis
Argum
ent: The firm
has excess cash on its hands this year, noinvestm
ent projects this year and wants to give the m
oney back tostockholders.
Counter: So w
hy not just repurchase stock? If this is a one-time
phenomenon, the firm
has to consider future financing needs.C
onsider the cost of issuing new stock:
Asw
ath Dam
odaran147
The C
ost of Raising F
unds
Issuing new equity is m
uch more expensive than raising new
debt forcom
panies that are already publicly traded, in terms of transactions
costs and investment banking fees
Raising sm
all amounts is m
uch more expensive than raising large
amounts, for both equity and debt. M
aking a small equity issue ( say $
25-$ 50 million m
ight be prohibitively expensive)
Asw
ath Dam
odaran148
Are firm
s perverse? Som
e evidence that theyare not
Asw
ath Dam
odaran149
Evidence from
Canadian F
irms
Com
panyP
remium
for Cash dividend over
Stock Dividend Shares
Consolidated Bathurst19.30%
Donfasco13.30%
Dome Petroleum
0.30%
Imperial Oil
12.10%
New
foundland Light & Pow
er1.80%
Royal Trustco17.30%
Stelco2.70%
TransAlta1.10%
Average
7.54%
Asw
ath Dam
odaran150
A clientele based explanation
Basis: Investors m
ay form clienteles based upon their tax brackets.
Investors in high tax brackets may invest in stocks w
hich do not paydividends and those in low
tax brackets may invest in dividend paying
stocks.
Evidence: A
study of 914 investors' portfolios was carried out to see if
their portfolio positions were affected by their tax brackets. T
he studyfound that•
(a) Older investors w
ere more likely to hold high dividend stocks and
•(b) Poorer investors tended to hold high dividend stocks
Asw
ath Dam
odaran151
Results from
Regression: C
lientele Effect
Dividend Y
ieldt = a + b βt + c Aget + d Incom
et + e Differential Tax R
atet + εt
Variable
Coefficient
Implies
Constant
4.22%
Beta C
oefficient-2.145
Higher beta stocks pay low
er dividends.
Age/100
3.131Firm
s with older investors pay higher
dividends.
Income/1000
-3.726Firm
s with w
ealthier investors pay lower
dividends.
Differential Tax R
ate-2.849
If ordinary income is taxed at a higher rate
than capital gains, the firm pays less
dividends.
Asw
ath Dam
odaran152
Dividend P
olicy and Clientele
Assum
e that you run a phone company, and that you have historically
paid large dividends. You are now
planning to enter thetelecom
munications and m
edia markets. W
hich of the following paths
are you most likely to follow
?
Courageously announce to your stockholders that you plan to cut
dividends and invest in the new m
arkets.
Continue to pay the dividends that you used to, and defer investm
entin the new
markets.
Continue to pay the dividends that you used to, m
ake the investments
in the new m
arkets, and issue new stock to cover the shortfall
Other
Asw
ath Dam
odaran153
The S
ignaling Hypothesis
Asw
ath Dam
odaran154
An A
lternative Story..D
ividends as Negative
Signals
Asw
ath Dam
odaran155
The W
ealth Transfer H
ypothesis
-2
-1.5 -1
-0.5 0
0.5
t:-1
5-1
2-9
-6-3
03
69
12
15
CA
R (D
iv Up)
CA
R (D
iv down)
EX
CE
SS
RE
TUR
NS
ON
STR
AIG
HT B
ON
DS
AR
OU
ND
DIV
IDE
ND
CH
AN
GE
S
Day (0: A
nnouncement date)
CAR
Asw
ath Dam
odaran156
Managem
ent Beliefs about D
ividend Policy
A firm
’s dividend payout ratio affects its stock price.
Dividend paym
ents operate as a signal to financial markets
Dividend announcem
ents provide information to financial m
arkets.
Investors think that dividends are safer than retained earnings
Investors are not indifferent between dividends and price appreciation.
Stockholders are attracted to firms that have dividend policies that they
like.
Asw
ath Dam
odaran157
Determ
inants of Dividend P
olicy
Investment O
pportunities: More investm
ent opportunities - > L
ower
Dividends
Stability in earnings: More stable earnings ->
Higher D
ividends
Alternative sources of capital: M
ore alternative sources -> H
igherD
ividends
Constraints: M
ore constraints imposed by bondholders and lenders ->
Low
er Dividends
Signaling Incentives: More options to supply inform
ation to financialm
arkets - Low
er need to pay dividends as signal
Stockholder characteristics: Older, poorer stockholders ->
Higher
dividends
Asw
ath Dam
odaran158
Questions to A
sk in Dividend P
olicy Analysis
How
much could the com
pany have paid out during the period underquestion?
How
much did the the com
pany actually pay out during the period inquestion?
How
much do I trust the m
anagement of this com
pany with excess
cash?•
How
well did they m
ake investments during the period in question?
•H
ow w
ell has my stock perform
ed during the period in question?
Asw
ath Dam
odaran159
A M
easure of How
Much a C
ompany C
ouldhave A
fforded to Pay out: F
CF
E
The Free C
ashflow to E
quity (FCFE
) is a measure of how
much cash
is left in the business after non-equity claimholders (debt and preferred
stock) have been paid, and after any reinvestment needed to sustain the
firm’s assets and future grow
th.N
et Income
+ D
epreciation & A
mortization
= C
ash flows from
Operations to E
quity Investors
- Preferred Dividends
- Capital E
xpenditures
- Working C
apital Needs
- Principal Repaym
ents
+ Proceeds from
New
Debt Issues
= Free C
ash flow to E
quity
Asw
ath Dam
odaran160
Estim
ating FC
FE
when Leverage is S
table
Net Incom
e
- (1- δ) (Capital E
xpenditures - Depreciation)
- (1- δ) Working C
apital Needs
= Free C
ash flow to E
quity
δ = D
ebt/Capital R
atio
For this firm,
•Proceeds from
new debt issues =
Principal Repaym
ents + δ (C
apitalE
xpenditures - Depreciation +
Working C
apital Needs)
Asw
ath Dam
odaran161
An E
xample: F
CF
E C
alculation
Consider the follow
ing inputs for Microsoft in 1996. In 1996,
Microsoft’s FC
FE w
as:•
Net Incom
e = $2,176 M
illion
•C
apital Expenditures =
$494 Million
•D
epreciation = $ 480 M
illion
•C
hange in Non-C
ash Working C
apital = $ 35 M
illion
•D
ebt Ratio =
0%
FCFE
= N
et Income - (C
ap ex - Depr) (1-D
R) - C
hg WC
(!-DR
) =
$ 2,176- (494 - 480) (1-0)
- $ 35 (1-0)
=
$ 2,127 Million
Asw
ath Dam
odaran162
Microsoft: D
ividends?
By this estim
ation, Microsoft could have paid $ 2,127 M
illion individends/stock buybacks in 1996. T
hey paid no dividends and boughtback no stock. W
here will the $2,127 m
illion show up in M
icrosoft’sbalance sheet?
Asw
ath Dam
odaran163
Dividends versus F
CF
E: U
.S.
Fig
ure
1
1.1
: D
ivid
en
ds
/FC
FE
:
NY
SE
F
irms
in
1
99
6
0
20
0
40
0
60
0
80
0
10
00
12
00
14
00
16
00
18
00
0 %
0 -10%
10 -20%
20- 30%
30 - 40%
4 0 - 5 0 %
50 - 60%
60 -70%
70 - 80%
80 -90%
90 - 100%
> 100%
Div
ide
nd
s/F
CF
E
Number of Firms
Asw
ath Dam
odaran164
The C
onsequences of Failing to pay F
CF
E
Ch
rys
ler: F
CF
E, D
ivid
en
ds
an
d C
as
h B
ala
nc
e
($5
00
)
$0
$5
00
$1
,00
0
$1
,50
0
$2
,00
0
$2
,50
0
$3
,00
0
19
85
19
86
19
87
19
88
19
89
19
90
19
91
19
92
19
93
19
94
Ye
ar
Cash Flow
$0
$1
,00
0
$2
,00
0
$3
,00
0
$4
,00
0
$5
,00
0
$6
,00
0
$7
,00
0
$8
,00
0
$9
,00
0
Cash Balance
= F
ree
CF
to E
qu
ity =
Ca
sh to
Sto
ckho
lde
rsC
umulated C
ash
Asw
ath Dam
odaran165
Application T
est: Estim
ating your firm’s
FC
FE
In General,
If cash flow statem
ent usedN
et Income
Net Incom
e+
Depreciation &
Am
ortization+
Depreciation &
Am
ortization- C
apital Expenditures
+ C
apital Expenditures
- Change in N
on-Cash W
orking Capital
+ C
hanges in Non-cash W
C- Preferred D
ividend+
Preferred Dividend
- Principal Repaid
+ Increase in L
T B
orrowing
+ N
ew D
ebt Issued+
Decrease in L
T B
orrowing
+ C
hange in ST B
orrowing
= FCFE
= FCFE
Com
pare toD
ividends (Com
mon)
-Com
mon D
ividend+
Stock Buybacks
- Decrease in �
�C
apital Stock+ Increase in �
Capital Stock
Asw
ath Dam
odaran166
A P
ractical Fram
ework for A
nalyzing Dividend
Policy
How
much did the firm
pay out? How
much could it have afforded to pay out?
What it could have paid out
What it actually paid out
Net Incom
eD
ividends- (C
ap Ex - D
epr’n) (1-DR
)+
Equity R
epurchase- C
hg Working C
apital (1-DR
)= F
CF
E
Firm
pays out too littleF
CF
E > D
ividendsF
irm pays out too m
uchF
CF
E < D
ividends
Do you trust m
anagers in the company w
ithyour cash?Look at past project choice:C
ompare
RO
E to C
ost of Equity
RO
C to W
AC
C
What investm
ent opportunities does the firm
have?Look at past project choice:C
ompare
RO
E to C
ost of Equity
RO
C to W
AC
C
Firm
has history of good project choice and good projects in the future
Firm
has historyof poor project choice
Firm
has good projects
Firm
has poor projects
Give m
anagers the flexibility to keep cash and set dividends
Force m
anagers to justify holding cash or return cash to stockholders
Firm
should cut dividends and reinvest m
ore
Firm
should deal w
ith its investment
problem first and
then cut dividends
Asw
ath Dam
odaran167
A D
ividend Matrix
FC
FE
- Divid
end
s
Good P
rojectsP
oor Projects
Maxim
umF
lexibility in D
ividend Policy
Reduce cash
payout to stockholders
Significant
pressureon m
anagers to pay cash out
Investment and
Dividend
problems; cut
dividends but also check project choice
Asw
ath Dam
odaran168
Disney: A
n analysis of FC
FE
from 1992-1996
Year
Net Incom
e(C
ap Ex- D
epr) C
hg in WC
FC
FE
(1- Debt R
atio)(1-D
ebt Ratio)
1992$817
$173 ($81)
$725
1993$889
$328 $160
$402
1994$1,110
$469 $498
$143
1995$1,380
$325 $206
$849
1996*$1,214
$466 ($470)
$1,218
Avge
$1,082 $352
$63$667
(The num
bers for 1996 are reported without the C
apital Cities
Acquisition)
The debt ratio used to estim
ate the free cash flow to equity w
as estimated
as follows =
Net D
ebt Issues/(Net C
ap Ex +
Change in N
on-cash WC
)
Asw
ath Dam
odaran169
Disney’s D
ividends and Buybacks from
1992 to1996
Year
FCFE
Dividends +
Stock Buybacks
1992$725
$105
1993$402
$160
1994$143
$724
1995$849
$529
1996$1,218
$733
Average
$667 $450
Asw
ath Dam
odaran170
Disney: D
ividends versus FC
FE
Disney paid out $ 217 m
illion less in dividends (and stock buybacks)than it could afford to pay out. H
ow m
uch cash do you think Disney
accumulated during the period?
Asw
ath Dam
odaran171
Can you trust D
isney’s managem
ent?
During the period 1992-1996, D
isney had•
an average return on equity of 21.07% on projects taken
•earned an average return on 21.43%
for its stockholders
•a cost of equity of 19.09%
Disney has taken good projects and earned above-m
arket returns for itsstockholders during the period.
If you were a D
isney stockholder, would you be com
fortable with
Disney’s dividend policy?
Yes
No
Asw
ath Dam
odaran172
Disney: R
eturn Perform
ance Trends
Re
turn
s o
n E
qu
ity, S
toc
k a
nd
Re
qu
ired
Re
turn
s - D
isn
ey
-10
.00
%
0.0
0%
10
.00
%
20
.00
%
30
.00
%
40
.00
%
50
.00
%
60
.00
%
19
92
19
93
19
94
19
95
19
96
Ye
ar
RO
ER
etu
rns o
n S
tock
Re
qu
ired
Re
turn
Asw
ath Dam
odaran173
The B
ottom Line on D
isney Dividends
Disney could have afforded to pay m
ore in dividends during the periodof the analysis.
It chose not to, and used the cash for the AB
C acquisition.
The excess returns that D
isney earned on its projects and its stock overthe period provide it w
ith some dividend flexibility. T
he trend in thesereturns, how
ever, suggests that this flexibility will be rapidly depleted.
The flexibility w
ill clearly not survive if the AB
C acquisition does not
work out.
Asw
ath Dam
odaran174
Aracruz: D
ividends and FC
FE
: 1994-1996
19941995
1996N
et Income
BR
248.21 B
R326.42
BR
47.00 - (C
ap. Exp - D
epr)*(1-DR
)B
R174.76
BR
197.20 B
R14.96
- ∂ Working C
apital*(1-DR
)(B
R47.74)
BR
15.67 (B
R23.80)
= Free C
F to Equity
BR
121.19 B
R113.55
BR
55.84
Dividends
BR
80.40 B
R113.00
BR
27.00 +
Equity R
epurchasesB
R 0.00
BR
0.00B
R 0.00
= C
ash to StockholdersB
R80.40
BR
113.00 B
R27.00
Asw
ath Dam
odaran175
Aracruz: Investm
ent Record
19941995
1996P
roject Perform
ance Measures
RO
E19.98%
16.78%2.06%
Required rate of return
3.32%28.03%
17.78% D
ifference16.66%
-11.25%-15.72%
Stock Perform
ance Measure
Returns on stock
50.82%-0.28%
8.65%R
equired rate of return3.32%
28.03%17.78%
Difference
47.50%-28.31%
-9.13%
Asw
ath Dam
odaran176
Aracruz: Its your call..
Assum
e that you are a large stockholder in Aracruz. T
hey have ahistory of paying less in dividends than they have available in FC
FEand have accum
ulated a cash balance of roughly 1 billion BR
(25% of
the value of the firm). W
ould you trust the managers at A
racruz with
your cash?
Yes
No
Asw
ath Dam
odaran177
Mandated D
ividend Payouts
There are m
any countries where com
panies are mandated to pay out a
certain portion of their earnings as dividends. Given our discussion of
FCFE
, what types of com
panies will be hurt the m
ost by these laws?
Large com
panies making huge profits
Small com
panies losing money
High grow
th companies that are losing m
oney
High grow
th companies that are m
aking money
Asw
ath Dam
odaran178
BP
: Dividends- 1983-92
12
34
56
78
910
Net Incom
e$1,256.00
$1,626.00$2,309.00
$1,098.00$2,076.00
$2,140.00$2,542.00
$2,946.00$712.00
$947.00
- (Cap. E
xp - Depr)*(1-D
R)
$1,499.00$1,281.00
$1,737.50$1,600.00
$580.00$1,184.00
$1,090.50$1,975.50
$1,545.50$1,100.00
∂ Working C
apital*(1-DR
)$369.50
($286.50)$678.50
$82.00($2,268.00)
($984.50)$429.50
$1,047.50($305.00)
($415.00)
= Free C
F to Equity
($612.50)$631.50
($107.00)($584.00)
$3,764.00$1,940.50
$1,022.00($77.00)
($528.50)$262.00
Dividends
$831.00$949.00
$1,079.00$1,314.00
$1,391.00$1,961.00
$1,746.00$1,895.00
$2,112.00$1,685.00
+ E
quity Repurchases
= C
ash to Stockholders$831.00
$949.00$1,079.00
$1,314.00$1,391.00
$1,961.00$1,746.00
$1,895.00$2,112.00
$1,685.00
Dividend R
atios
Payout Ratio
66.16%58.36%
46.73%119.67%
67.00%91.64%
68.69%64.32%
296.63%177.93%
Cash Paid as %
of FCFE
-135.67%150.28%
-1008.41%-225.00%
36.96%101.06%
170.84%-2461.04%
-399.62%643.13%
Perform
ance Ratios
1. Accounting M
easure
RO
E9.58%
12.14%19.82%
9.25%12.43%
15.60%21.47%
19.93%4.27%
7.66%
Required rate of return
19.77%6.99%
27.27%16.01%
5.28%14.72%
26.87%-0.97%
25.86%7.12%
Difference
-10.18%5.16%
-7.45%-6.76%
7.15%0.88%
-5.39%20.90%
-21.59%0.54%
Asw
ath Dam
odaran179
BP
: Sum
mary of D
ividend Policy
Summ
ary of calculations
Average
Standard Deviation
Maxim
umM
inimum
Free C
F to E
quity$571.10
$1,382.29$3,764.00
($612.50)
Dividends
$1,496.30$448.77
$2,112.00$831.00
Dividends+
Repurchases
$1,496.30$448.77
$2,112.00$831.00
Dividend P
ayout Ratio
84.77%
Cash P
aid as % of F
CF
E262.00%
RO
E - R
equired return-1.67%
11.49%20.90%
-21.59%
Asw
ath Dam
odaran180
BP
: Just Desserts!
Asw
ath Dam
odaran181
The Lim
ited: Sum
mary of D
ividend Policy:
1983-1992
Summ
ary of calculations
Average
Standard Deviation
Maxim
umM
inimum
Free C
F to E
quity($34.20)
$109.74$96.89
($242.17)
Dividends
$40.87$32.79
$101.36$5.97
Dividends+
Repurchases
$40.87$32.79
$101.36$5.97
Dividend P
ayout Ratio
18.59%
Cash P
aid as % of F
CF
E-119.52%
RO
E - R
equired return1.69%
19.07%29.26%
-19.84%
Asw
ath Dam
odaran182
Grow
th Firm
s and Dividends
High grow
th firms are som
etimes advised to initiate dividends because
its increases the potential stockholder base for the company (since
there are some investors - like pension funds - that cannot buy stocks
that do not pay dividends) and, by extension, the stock price. Do you
agree with this argum
ent?
Yes
No
Why?
Asw
ath Dam
odaran183
Application T
est: Assessing your firm
’sdividend policy
Com
pare your firm’s dividends to its FC
FE, looking at the last 5 years
of information.
Based upon your earlier analysis of your firm
’s project choices, would
you encourage the firm to return m
ore cash or less cash to its owners?
If you would encourage it to return m
ore cash, what form
should ittake (dividends versus stock buybacks)?
Asw
ath Dam
odaran184
Other A
ctions that affect Stock P
rices
In the case of dividends and stock buybacks, firms change the value of
the assets (by paying out cash) and the number of shares (in the case of
buybacks).T
here are other actions that firms can take to change the value of their
stockholder’s equity.•
Divestitures: T
hey can sell assets to another firm that can utilize them
more efficiently, and claim
a portion of the value.•
Spin offs: In a spin off, a division of a firm is m
ade an independent entity.T
he parent company has to give up control of the firm
.•
Equity carve outs: In an E
CO
, the division is made a sem
i-independententity. T
he parent company retains a controlling interest in the firm
.•
Tracking Stock: W
hen tracking stock are issued against a division, theparent com
pany retains complete control of the division. It does not have
its own board of directors.
Asw
ath Dam
odaran185
Differences in these actions
Asset com
pletelycovenrted into cash
No cash for
transaction
Control fully lost
Parent com
panhy preservescontrol
Taxed on capital gains
No T
axes
Bondholders negatively
affected
Bondholders
unaffected
Divestitures
Spin offs
EC
OTracking stock
Divestitures
Spin offs
EC
OTracking stock
Divestitures
Spin offs
Divestitures
Tracking stock
EC
Os
Trackingstock
Spin offs
EC
O