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Dividend Policy

Dividend Policy. May 2, 2007 (LA) and May 1, 2007 (OCC). Raising Funds in United States. Available funds Internal funds Current shareholders Private sources: banks, private placements Public Sources: short-term, long-term Securities Acts of 1933 and 1934

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Dividend Policy

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  1. Dividend Policy May 2, 2007 (LA) and May 1, 2007 (OCC)

  2. Raising Funds in United States • Available funds • Internal funds • Current shareholders • Private sources: banks, private placements • Public Sources: short-term, long-term • Securities Acts of 1933 and 1934 • Investment bankers and costs of funds

  3. Capital Structure in Practice • Most firms in the U. S. are mainly equity financed despite tax advantage of debt • Most firm financing is internally generated cash in the U. S. • U.S. firms use less debt (Table 16.4, p. 480) • Debt markets • Bank and privately placed debt in Japan, EEC • Public debt markets and banks in U.S.

  4. Dividend Policy • The dividend decision • Board of directors deliberation • Dividends and investment • Announcement and payment of dividend • Dividends as a source of cash for investors • Tax treatment of dividends • Individuals and other investors • Combination of corporate and individuals • Equilibrium in capital markets

  5. Summary M-M Debate Issues

  6. M-M Dividend Irrelevance • Assume no taxation and efficient markets • Stockholders can create cash flows equivalent to dividends by selling shares • Shareholders not needing cash can reinvest dividends in stock • Reinvested earnings (not paid as dividends) grow at firm’s rate of return and produce gains • New equity dilutes old claims on income

  7. Investment and Dividends • Firms should invest in all NPV>0 projects • Investment determines a firm’s value: • Value of firm (with or without debt) depends on the value from investments • Cash dividends increase need for new equity

  8. Dividend Debate • Taxation issues (past and current) • Information in dividends • Cash payment signals real cash flows • Smoothing implies information on future cash • Tax effects may be offset • Clientele effects • Miller-Scholes strategies can eliminate problem • Evidence

  9. Course Summary and Review

  10. Corporate Financial Decisions • Investments • Long-term strategic commitments of capital • Tangible and intangible, projects or companies • Financing • Debt or equity • Term, conditions, commitments • Working Capital • Cash • Inventory and accounts receivable • Short-term borrowing and accounts payable

  11. Corporate Finance Questions • What determines asset values and how do interest rates and expectations affect them? • Which projects should we invest in? • Which risks are important for investors? • How can we measure and adjust for risk? • Does a firm’s financing or dividend policy matter?

  12. Determinants of Value • Cash, Time, Riskdetermine value • Present value analysis deals with the effect of time or timing on value • Cash flow estimation is the subject of the next part of the course (classes 5 to 8) • Risk is incorporated in the discount ratethat we discuss in Part 3 of the course • Positive net present valueprojects create value for investors

  13. Required Rates of Return • Investors require compensation for systematic risk • If expected returns from a project or an asset is higher than the required rate, it has positive net present value • Equivalently, its internal rate of return is higher than the opportunity rate • Security market line is relation between systematic risk and required rates in CAPM

  14. Rigor implies Mathematics • Multi-period expressions with factors raised to powers (present value calculations in Chapter 4) • Polynomial functions mean non-linear relations • Sometimes more than one way to solve a problem • Arithmetic, but in large doses (projections in Chapter 7) • Addition and subtraction, ratios (division) and muliplication, • Many calculations, not difficult calculations • Statistical concepts like correlation (analysis of risk in Chapters 10 and 12) • Algebra using equations and unknowns (theory of capital structure in Chapter 15)

  15. Main Analytical Material in Corporate Finance • Chapters 4 and 5 - Present value and valuation of stocks and bonds • Chapter 7 - Investment project evaluation • Chapters 9, 10 and 12 - Portfolio theory, CAPM, and capital budgeting with risk • Chapter 13 - Efficient markets • Chapters 15, 16, and 18 - M-M theories and debate on capital structure and dividends

  16. Optional Review Materials • Summary of Finance Principles Every MBA Should Know posted on website • Compilation of Objectives, Important Vocabulary, and Wall Street Journal Articles • Old final and midterm examinations

  17. Important WSJ Stories 2007 • Challenges facing auto industry in restructuring • Increasing role of private-equity firms in corporate restructuring, including in GM and Chrysler cases • Private-equity firms going public • Costs of SOX compliance continues to be a major issue • SEC and press focus on executive compensation

  18. GSBA 548, Finance & the Future • First goal: prepare students to deal with an environment where finance professionals partially determine the environment • Finance is a branch of rhetoric • The are no right answers but there are coherent and persuasive answers • Second goal: induce sympathy for the financial view of the world

  19. Finance View of the World • Your personal world • Return on your investments, including human capital • Approach to personal financial management • The real world • Corporate governance: goals of policy, relation of policy to efficiency • Dynamism and complexity of financial markets

  20. Current Developments in Finance • Deepening of consumer financial services markets similar to deepening of wholesale markets • Refinement of market allocation of risks and returns, making markets more efficient • Changes in demand and supply of equity and debt and issues in valuation of residual and fixed claims • Technology, globalization, deregulation

  21. Final Examination • Open book, open note, 6:00-8:30pm • Calculator, #2 pencil, and pen • 25 multiple choice and 3 long answer • 1/3 covers first half of course, 2/3 last half • Questions from course objectives, important vocabulary, end-of-chapter problems, class exercises, and group project • Review sessions with TAs and instructor

  22. Likely Questions • Major material from key chapters not covered extensively in midterm examination • Hardest questions on midterm considered straightforward by instructor • Applications of problem-solving of basic finance principles covered extensively in class

  23. Good Luck!! • Teaching assistants and I want you to do well on the final and group project • We are not trying to tell you how to study for the final but want to make everything you might need available in a convenient format • We hope to see you in finance classes in the future

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