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Review

Review. Goal: M aximize Value of the Firm Past Topics Investment Decision (spending money) Financing Decision (raising money) Future Topics “Variations on a Theme”. Today’s Topics. Dividends Define (CB / Investment variation)

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Review

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  1. Review • Goal: Maximize Value of the Firm • Past Topics • Investment Decision (spending money) • Financing Decision (raising money) • Future Topics • “Variations on a Theme”

  2. Today’s Topics • Dividends • Define (CB / Investment variation) • Div & Value of the Firm • Capital Structure • Define (financing variation) • Cap Str & Value of the Firm

  3. Dividends • A payment made by a company to the shareholders of the company.

  4. Types of Dividends • Cash Div • Regular Cash Div • Special Cash Div • Stock Div • Stock Repurchase (4 methods) • 1. Buy shares on the market • 2. Tender Offer to Shareholders • 3. Dutch Auction • 4. Private Negotiation (Green Mail)

  5. Dividend Terms • Record Date • Announcement Date • Payment Date • Ex-Dividend

  6. Dividend Payments Aug 14 Aug 25 Aug26 Sept 1 Sept 15 Declaration With- Ex-dividend Record Payment date dividend date date date date Share price falls

  7. Div & Value (M&M Theory) • Example: • Assume ABC Co. has no extra cash, but declares a $1,000 dividend. They also require $1,000 for current investment needs. Using M&M Theory, and given the following balance sheet information, show how the value of the firm is not altered when new shares are issued to pay for the dividend. • Record Date • Cash 1,000 • Asset Value 5,000 • Total Value 6,000 • # of Shares 200 • price/share $30

  8. Div & Value (M&M Theory) • Example: • Assume ABC Co. has no extra cash, but declares a $1,000 dividend. They also require $1,000 for current investment needs. Using M&M Theory, and given the following balance sheet information, show how the value of the firm is not altered when new shares are issued to pay for the dividend. • Record Date Pmt Date • Cash 1,000 0 • Asset Value 5,000 5,000 • Total Value 6,000 5,000 • # of Shares 200 200 • price/share $30 $25

  9. Div & Value (M&M Theory) • Example: • Assume ABC Co. has no extra cash, but declares a $1,000 dividend. They also require $1,000 for current investment needs. Using M&M Theory, and given the following balance sheet information, show how the value of the firm is not altered when new shares are issued to pay for the dividend. • Record Date Pmt Date Post Pmt • Cash 1,000 0 1,000 (40sh @ $25) • Asset Value 5,000 5,000 5,000 • Total Value 6,000 5,000 6,000 • # of Shares 200 200 240 • price/share $30 $25 $25

  10. Div & Value (M&M Theory) • Shareholder Value • Record • Stock 6,000 • Cash 0 • Total 6,000 • Stock = 200 sh @ $30 = 6,000

  11. Div & Value (M&M Theory) • Shareholder Value • Record Pmt • Stock 6,000 5,000 • Cash 0 1,000 • Total 6,000 6,000 • Stock = 200sh @ $25 = 5,000

  12. Div & Value (M&M Theory) • Shareholder Value • Record Pmt Post • Stock 6,000 5,000 6,000 • Cash 0 1,000 0 • Total 6,000 6,000 6,000 • Stock = 240sh @ $25 = 6,000

  13. Dividend Theories • Leftists (M&M) - Div does not effect value • Rightists - Dividends increase value • Middle of the roaders - Leftist theory with some reality thrown in.

  14. Dividends Increase Value • Market Imperfections and Clientele Effect • There are natural clients for high-payout stocks, but it does not follow that any particular firm can benefit by increasing its dividends. The high dividend clientele already have plenty of high dividend stock to choose from. • These clients increase the price of the stock through their demand for a dividend paying stock.

  15. Dividends Increase Value • Dividends as Signals • Dividend increases send good news about cash flows and earnings. Dividend cuts send bad news. • Because a high dividend payout policy will be costly to firms that do not have the cash flow to support it, dividend increases signal a company’s good fortune and its manager’s confidence in future cash flows.

  16. Dividends Decrease Value • Tax Consequences • Companies can convert dividends into capital gains by shifting their dividend policies. If dividends are taxed more heavily than capital gains, taxpaying investors should welcome such a move and value the firm more favorably. • In such a tax environment, the total cash flow retained by the firm and/or held by shareholders will be higher than if dividends are paid.

  17. Taxes and Dividend Policy • Since capital gains are taxed at a lower rate than dividend income, companies should pay the lowest dividend possible. • Dividend policy should adjust to changes in the tax code.

  18. Taxes and Dividend Policy In U.S., shareholders are taxed twice (figures in dollars)

  19. Taxes and Dividend Policy Under imputed tax systems, such as that in Australia, Shareholders receive a tax credit for the corporate tax the firm pays (figures in Australian dollars)

  20. Capital Sturcture • Review Ch 17 on your own • Overview revisited now

  21. M&M (Debt Policy Doesn’t Matter) Example - Macbeth Spot Removers - All Equity Financed Expected outcome

  22. M&M (Debt Policy Doesn’t Matter) Example cont. 50% debt

  23. M&M (Debt Policy Doesn’t Matter) Example - Macbeth’s - All Equity Financed - Debt replicated by investors

  24. No Magic in Financial Leverage MM'S PROPOSITION I If capital markets are doing their job, firms cannot increase value by tinkering with capital structure. V is independent of the debt ratio. AN EVERYDAY ANALOGY It should cost no more to assemble a chicken than to buy one whole.

  25. Proposition I and Macbeth Macbeth continued

  26. Leverage and Returns

  27. M&M Proposition II Macbeth continued

  28. M&M Proposition II Macbeth continued

  29. M&M Proposition II r rE rA rD D E Risk free debt Risky debt

  30. Leverage and Risk Macbeth continued Leverage increases the risk of Macbeth shares

  31. Leverage and Returns

  32. WACC • WACC is the traditional view of capital structure, risk and return.

  33. WACC Expected Return .20=rE Equity .15=rA All assets .10=rD Debt Risk BD BA BE

  34. WACC • Example - A firm has $2 mil of debt and 100,000 of outstanding shares at $30 each. If they can borrow at 8% and the stockholders require 15% return what is the firm’s WACC? D = $2 million E = 100,000 shares X $30 per share = $3 million V = D + E = 2 + 3 = $5 million

  35. WACC • Example - A firm has $2 mil of debt and 100,000 of outstanding shares at $30 each. If they can borrow at 8% and the stockholders require 15% return what is the firm’s WACC? D = $2 million E = 100,000 shares X $30 per share = $3 million V = D + E = 2 + 3 = $5 million

  36. WACC r rE rE =WACC rD D V

  37. WACC (traditional view) r rE WACC rD D V

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