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Dividend PolicyKiran Thapa

TopicsNature of dividend policy Payment procedureTypes of dividend policiesDeterminants of dividend policy Cash dividend and stock dividendsStock splits and reverse splitsRepurchase of stocks

Two approaches to dividend decision Income can be distributed to the shareholders dividend As a maximization of wealth decision. Income can be retained to finance long term growth. Sufficient profitable projects are available Capital structure needs equity funds.

Nature of dividend policy Payment ProcedureDeclaration date: Day on which the BOD declares the dividend.Holder of record date: Date the company opens the ownership books to determine who will receive the dividend.Ex-Dividend date: This date is 4 days prior to the record date. Shares purchased after the ex-dividend date are not entitled to the dividend. Payment date: This is the day when dividend checks are actually mailed to the holders of record.Constant dividend per share Constant dividend payout ratioLow regular dividends plus extrasResidual dividend policy

Types of dividend Policy Residual Dividend PolicyDetermine optimal capital budgetDetermine the amount of equity required to finance the capital budget.Use retained earnings Pay dividends after the investing in capital budgetDividends =Net income (capital budget equity ratio)

Determinants of dividend policy Size of the earningsLiquidity positionLegal rulesDesire of shareholdersRestrictions in debt contractsRate of asset expansionAccess to the capital markets

Forms of DividendsCash dividends- Company mostly pay dividends in cash.- Market price drops by the amount of cash dividend per share- Retained earnings will be reduced by total cash dividend paid.- Net worth will be reduced by total cash dividend paid- Cash will be reduced by the total cash dividends paid

Forms of dividends contd. Stock Dividend or bonus share- Distribution of additional shares to a firms shareholders- Increases the number of shares- Stock dividend is used as a replacement of cash dividend.- There is no cash involved in a stock dividend.- Net worth remains constant. - Retained earnings will decreased.

Common stock and paid in capital will increased Market price will decrease New MPS = MPS before stock dividend / (1 + stock dividend in fraction)

Reasons for stock dividend- Conserve cash- Increase liquidity - Retains proportional ownership for shareholdersStock dividend contd.Advantages - Tax benefits- Indication of higher future profits- Future dividends may increase - Psychological valueDisadvantages - More costly - Wealth remains unaffected- Problem of adjusting EPS and P/E ratio

Stock dividend contd. Stock Split- Issue of additional shares to the firms stockholders- Increases number of shares- Decreases par value of stock- Decreases the market price of the stock- Increased liquidity- Net worth remains constant. for example: 2 for 1, 3 for 1 etc.Stock split vs Reverse SplitReverse split Used to increase the price of the stockDecrease the number of shares.Increase the market priceIncrease par value Net worth remains the same.For example, 1 for 2, 1 for 3 etc.

Buying own stock back from stockholders Also known as Treasury stock or acquire stockReasons for repurchases- As an alternative to distributing cash as dividends.- To increase the market price of the stock.- To use when employees exercise stock options- Use to retire the stocks

Stock RepurchaseMethod of repurchaseOpen market Tender offer Negotiation basisCalculation of repurchase priceRepurchase price = MPS before repurchase /(1 number of shares repurchased in fraction)

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Any queries?Thank You?Problem 1 A Corporation has had the earnings per share of Re 0.60, Re. 0.60, Rs 1,Rs 1 and Rs 2 in year 1 to 5 respectively. a.If the firm's dividend policy is based on a constant payout ratio of 40 percent for all years with positive earnings, determine the annual dividend paid in each year. b.If the firm has a regular dividend policy of paying Rs. 0.55 per share per share, regardless of the per share earnings, determine the annual dividend paid in each year.c. If firm's policy is to pay out Rs. 0.30 per share each period, except in those periods when earnings are above Rs. 0.70; when they pay out an extra dividend equal to 20 percent of the earnings above Rs. 0.70, determine the amount of regular and extra dividends paid each year.Ans: a. Rs 0.24; 0.24; 0.40; 0.40; and 0.80; b. Rs 0.55 per year; c. Rs 0.30; 0.30; 0.36; 0.36; and 0.56

Problem 2a.Amita Telecommunications has a target capital structure that consists of 70 percent debt and 30 percent equity. The Company anticipates that its capital budget for the upcoming year will be Rs. 3,000,000. If Amita reports net income of Rs. 2,000,000 and it follows a residual dividend payout policy, what will be its dividend payout ratio?b. Peterson Company has a capital budget of Rs. 1.2 million. The company wants to maintain a target capital structure that is 60 percent debt and 40 percent equity. The company forecasts that its net income this year will be Rs. 600,000. If the company follows a residual dividend policy, what will be its payout ratio?c. Lumbini Sugar Mill has a current and target capital structure of 30 percent debt and 70 percent equity. This past year Lumbini, which uses a residual theory dividend policy, had a dividend payout ratio of 47.5 percent and net income of Rs.800,000. What was Lumbini's capital budget?Ans: a. 55%; c. 20%; d. Rs 600,000

Problem 3A firm has 500,000 outstanding shares of Rs 2 par common stock, a contributed capital in excess of par account of Rs 8.4 million and retained earnings of Rs 32 million, all before the declaration of dividends. The board of directors declared a Rs 3 per share cash dividend. The market price of the stock is Rs 35 per share. a. What are the balances in the equity accounts before and after cash dividend? b. What will be the market price after cash dividend?

Problem 4Zoppo Manufacturers shareholders' equity Dec.30, 19X1:

Common stock (Rs.100 par, 300,000 shares) = Rs.30,000,000Additional paid in capital = Rs.15,000,000Retained earnings = Rs.55,000,000Shareholders' equity = Rs.100,000,000

On December 31, Zoppo split the stock two for one and then declared a 10 percent stock dividend. The price of the stock on December 30 was Rs.500. Reformulate the stockholders' capitalization accounts of the firm.

Problem 5Beta Industries has net income of Rs. 2,000,000 and it has 1,000,000 shares of common stock outstanding. The company's stock currently trades at Rs. 32 a share. Beta is considering a plan in which it will use available cash to repurchase 20 percent of its shares in the open market. The repurchase is expected to have no effect on either net income or the company's P/E ratio. What will be its stock price following the stock repurchase?