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Level 139

Dividend Policy

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investment, financing, and dividend decisions
The value of a firm is influenced by:
Passive Residual Policy
A firm should retain its earnings as long as it has investment opportunities that promise higher rates of return than the required rate
growth firms have low dividend payouts
What does a passive residual policy tell us?
Stable Dollar Dividend Policy
Reluctance to reduce dividends
What does stable dollar dividend policy tell us?
Increase in dividends means a decrease in earnings
Dividend Reinvestment Plans
Cash dividends reinvested automatically into additional shares
tax considerations
Share repurchases as dividend decisions
Capital gains income
Advantages of share repurchases as dividend decisions
May overpay for stock
Disadvantages of share repurchases as dividend decisions
EBIT Break Even
Interest - Dp/1-tax
Earnings Per Share (EPS)
Earnings Available Common Stock/N
DOL see-saw
Fixed costs affecting EBIT
DFL see-saw
Dp, Interest, N affecting EPS
DOL and DFL affecting EPS
Advantages of Residual Policy
Since it uses RE it reduces new stock issues and thus flotation costs(and signaling?), which would reduce the WACC.
Disadvantages of Residual Policy
Since investment opportunities and earnings surely vary from year to year, strict adherence to the policy results in unstable dividends, increased risk, unintended signals, resulting in a higher rs and lower stock price.
Conclusion of Residual Policy
A firm should use residual policy to help set its long-run target payout ratios. Not as a guide for any one year however, a firm should never follow it rigidly.
Old Stock Plan
A bank takes total funds for reinvestment purchases stock on the open market. Allocates purchased shares on a pro rata basis. Lowers transaction costs because of volume.
New Stock Plan
Dividends to be reinvested are used to buy newly issued stock . No Fees to Stock Holder. Usually 3-5% discount as a trade-off against flotation costs that would have been incurred if the stock were issued through investments bankers.
High DRIP participation
suggests that stockholders might be better off with reduced cash dividends, saving stockholders personal income taxes.
Bond Indentures
Debt contracts often limit dividend payments to earnings generated after the loan was granted.
Preferred stock restrictions
common dividends cannot be paid if the company has omitted its preferred dividend.
Impairment of Capital
Dividend payments cannot exceed retained earnings.
Penalty Tax
if the irs can demonstrate a firm is intentionally holding down its payout ratio to help stockholders avoid personal taxes the firm is subject to heavy fines.
Stock Repurchases
May be used in situations where the firm has cash available for distribution to its shareholders and distributes this cash by repurchasing shares.
Stock repurchase advantage
provide cash to shareholders who want cash while allowing those who do not to delay its receipt.
Options with Repurchase policy
a company can set its dividend low enough to regularly pay dividends without a problem and then use repurchases fairly regularly to distribute excess cash.