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Intel Corporation–> Optimal Financial Structure and Dividend Policy
1. Calculate the DOL and DFL for the last 2 years. Did your company increased or decreased the overall risk? 2.What is the current capital structure of the company?
3. What would be the optimal capital structure of your company?
4. Analyse the Dividend policy of the company!
Determining the Finance Mix
Learning Objectives
1.
2.
3.
4.
5.
Understanding the difference between risk and financial risk.
Use the technique of break-even analysis in a variety of
analytical settings.
Distinguish among the financial concepts of operating
leverage, financial leverage, and combined leverage.
Calculate the firm’s degree of operating leverage, financial
leverage, and combined leverage.
Understand the concept of an optimal capital structure.
Learning Objectives
6.
7.
8.
9.
10.
Explain the main underpinnings of capital structure
theory.
Understand and be able to graph the moderate position
on capital structure importance.
Incorporate the concepts of agency costs and free cash
flow into a discussion on capital structure management.
Use the basic tools of capital structure management.
Understand how business risk and global sales impact
the multinational firm.
Slide Contents
1.
2.
3.
4.
5.
6.
7.
8.
9.
Principles Used in this chapter
Risk
Break-even Analysis
Operating and Financial leverage
Planning the Financing Mix
Capital Structure Theory
Capital Structure Management (Basic Tools)
Capital Structure Management (Survey Results)
Finance and the Multinational Firm
1. Principles Used in this Chapter
Principles Used in this Chapter
• Principle 1:
– The Risk-Return Tradeoff – We Won’t Take on Additional
Risk Unless We Expect to Be Compensated With Additional
Return
• Principle 3:
– Cash-Not Profits-Is King
• Principle 7:
– The Agency Problem – Managers Won’t Work for the
Owners Unless It’s in Their Best Interest
• Principle 8:
– Taxes Bias Business Solutions
2. Risk
Risk
• The variability associated with expected revenue or
income streams. Such variability may arise due to:
– Choice of business line (business risk).
– Choice of an operating cost structure (operating risk).
– Choice of capital structure (financial risk).
Business Risk
•
Business Risk is the variation in the firm’s expected earnings
attributable to the industry in which the firm operates. There
are four determinants of business risk:
1. The stability of the domestic economy
2. The exposure to, and stability of, foreign economies
3. Sensitivity to the business cycle, and
4. Competitive pressures in the firm’s industry.
Operating Risk
• Operating risk is the variation in the firm’s operating
earnings that results from the firm’s cost structure
(mix of fixed and variable operating costs).
• Earnings of firms with higher proportion of fixed
operating costs are more vulnerable to change in
revenues.
Financial Risk
Financial Risk is the variation in earnings as a
result of a firm’s financing mix or proportion of
financing that requires a fixed return.
3. Break-even Analysis
Break-even Analysis
• Break-even analysis is used to determine the
break-even quantity of a firm’s output by
examining the relationships among the firm’s cost
structure, volume of output, and profit.
• Break-even may be calculated in units or sales
dollars. Break-even point indicates the point of
sales or units at which EBIT is equal to zero.
Break-even Analysis
Use of break-even model enables the
financial officer:
1. To determine the quantity of output that must
be sold to cover all operating costs, as distinct
from financial costs.
2. To calculate the EBIT that will be achieved at
various output levels.
Keown Martin Petty –
Chapter 12
15
Elements of Break-even Model
Break-even analysis requires information on the
following:
1. Fixed Costs
2. Variable Costs
3. Total Revenue
4. Total Volume
Break-even analysis requires classification of costs
into two categories:
– Fixed costs or indirect costs
– Variable costs or direct costs
• Since all costs are variable in the long-run, break-
even analysis is a short-run concept.
Fixed or Indirect Costs
• These costs do not vary in total amount as sales volume or
the quantity of output changes.
– As production volume increases, fixed costs per unit of
product falls, as fixed costs are spread over a larger and
larger quantity of output (but total remains the same).
– Fixed costs vary per unit but remain fixed in total.
– The total fixed costs are generally fixed for a specific range of
output.
Break-even Point (BEP)
• BEP = Point at which EBIT equals zero
• EBIT = (Sales price per unit) (units sold)
– [(variable cost per unit) (units sold) + (total
fixed cost)]
BEP for Pierce Grain Company
Example
• Selling price = $10 per unit
• Variable cost = $6 per unit
• Fixed cost = $100,000
• BEP (Units) = Total Fixed costs
(Unit sales price – Unit variable cost)
= 100000/4 = 25000 units
4. Operating and Financial Leverage
Operating Leverage
• Operating leverage measures the sensitivity of the
firm’s EBIT to fluctuation in sales, when a firm has
fixed operating costs.
• If the firm has no fixed operating costs, EBIT will
change in proportion to the change in sales.
Operating Leverage
• Operating Leverage (OL) = % change in EBIT
% change in sales
• Thus % change in EBIT
= OL X % change in sales
Where :
% change in EBIT = EBITt1 – EBITt / EBITt
% Change in sales =Salest1 – Salest / Salest
Operating Leverage
Example: If a company has an operating leverage of 6,
then what is the change in EBIT if sales increase by 5%?
Percentage change in EBIT = Operating leverage X
Percentage change in sales = 5% x 6 = 30%
Thus if the firm increases sales by 5%, EBIT will increase by
30%
Operating Leverage
Operating leverage is present when:
– Percentage change in EBIT / Percentage change in
sales > 1.00
• The greater the firm’s degree of operating
leverage, the more the profits will vary in
response to change in sales.
Operating Leverage for
Pierce Grain
Operating Leverage for
Pierce Grain
• Due to operating leverage, even though the sales
increase by only 20%, EBIT increases by 120%. (and
vice versa, if sales dropped by 20%, EBIT will fall by
120%; see next slide)
• If Pierce had no operating leverage (i.e. all of its
operating costs were variable), then the increase in
EBIT would have been in proportion to increase in
sales, i.e. 20%.
Financial Leverage
• Financial leverage is financing a portion of the firm’s
assets with securities bearing a fixed rate of return in
hopes of increasing the return to the common
stockholders.
• Thus, the decision to use preferred stock or debt exposes
the common stockholders to financial risk.
• Variability of EBIT is magnified by firm’s use of financial
leverage.
Three financing plans for Pierce
Grain
Three financing plans for Pierce
Grain
• Plan A: 0% debt – no financial risk
• Plan B: 25% debt – moderate financial risk
• Plan C: 40% debt – higher financial risk
• See next slide for impact of financial leverage on
earnings per share (EPS). The use of financial
leverage magnifies the impact of changes in EBIT on
earnings per share.
• A firm is employing financial leverage and
exposing its owners to financial risk when:
– Percentage change in EPS divided by Percentage
change in EBIT is greater than 1.00
Combined Leverage
• Operating leverage causes changes in sales revenues to
cause even greater changes in EBIT; furthermore, changes
in EBIT due to financial leverage create large variations in
both EPS and total earnings available to common
shareholders.
• Not surprisingly, combining operating and financial leverage
causes rather large variations in EPS
Combined Leverage
• Combined Leverage = Percentage change in
EPS/Percentage change in sales
• Or combined leverage = Operating Leverage X
Financial Leverage
• See table 12-6
Combining Operating and
Financial Leverage
5. Planning the Financing Mix
Capital Structure
• Financial Structure
– Mix of all items that appear on the right-hand side of
the company’s balance sheet
• Capital Structure
– Mix of the long-term sources of funds used by the firm
– Financial Structure – Current liabilities = Capital
Structure
Financial Structure
Designing a prudent financial structure requires
answers to the following:
1. How should a firm best divide its total fund sources
between short- and long-term components?
2. Capital structure management: In what proportions
relative to the total should the various forms of
permanent financing be utilized?
• This chapter focuses on the second question.
Capital Structure Management
• A firm should mix the permanent sources of funds in
a manner that will maximize the company’s stock
price, or minimize the cost of capital.
• A proper mix of funds sources is called the “optimal
capital structure”.
6. Capital Structure Theory
Capital Structure Theory
• Theory focuses on the effect of financial leverage
on the overall cost of capital to the enterprise.
• In other words, Can the firm affect its overall cost
of funds, either favorably or unfavorably, by
varying the mixture of financing used?
• Firms strive to minimize the cost of using financial
capital.
M&M’s Independence Hypothesis
• According to Modigliani & Miller, neither the
total value of the firm nor the cost of capital is
influenced by the firm’s capital structure. In
other words, the financing decision is
irrelevant!
• Their conclusions were based on restrictive
assumptions (such as no taxes, perfect or
efficient markets).
M&M’s Independence Hypothesis
• Figure 12-5 that shows that firm’s value
remains the same , despite the differences in
financing mix.
M&M’s Independence Hypothesis
• Figure 12-6 shows that the firm’s cost of
capital remains constant , although cost of
equity rises with increased leverage.
Extensions to Independence
Hypothesis
• How is the capital structure decision affected
when we consider:
– Tax benefit on interest expense
– Possibility of financial distress
– Agency cost of debt
Impact of taxes on capital
structure
• Interest expense is tax deductible.
• Because interest is deductible, the use of debt
financing should result in higher total market value
for firms outstanding securities.
• Tax Shield benefit = rd(m)(t)
r = rate, m = principal, t = marginal tax rate
• Interest on debt is tax deductible.
==> higher the interest expense,
lower
the taxes
• Thus, one would suggest that firms should maximize
Debt … indeed, firms should go for 100% debt to
maximize tax shield benefits!!
• But, we generally do not see 100% debt in the real
world. Why not?
• Two possible explanations are:
– Bankruptcy costs
– Agency costs
Impact of Bankruptcy on Capital
structure
• The Probability that a firm will be unable to meet its debt
obligations increases with debt. Thus probability of
bankruptcy (and hence costs) increases with increased
leverage. Threat of financial distress causes the cost of debt to
rise.
• As financial conditions weaken, expected costs of default can
be large enough to outweigh the tax shield benefit of debt
financing.
Impact of Bankruptcy on Capital
structure
• So higher debt does not lead to higher value. After a point
debt reduces the value of the firm to shareholders.
• This explains a tendency to restrain from maximizing the use
of debt.
• Debt capacity indicates the maximum proportion of debt the
firm can include in its capital structure and still maintain its
lowest composite cost of capital (see figure 12-7).
Agency Costs
• To ensure that agent-managers act in shareholders best
interest, firms must:
1. Have proper incentives
2. Monitor decisions
-bonding the managers
-auditing financial statements
-structuring the organization in unique ways that limit useful managerial
decisions
-reviewing the costs and benefits of management perquisites
• The costs of the incentives and monitoring must be borne
by the stockholders.
Impact of Agency Costs on Capital
Structur
• Capital structure management also gives rise to agency costs.
Bondholders are principals as essentially they have given a loan
to the corporation, that is owned by shareholders.
• Agency problems stem from conflicts of interest between
stockholders and bondholders. For example, pursuing risky
projects may benefit stockholders, but may not be appreciated
by bondholders
• Bondholders greatest fear is default by corporation or misuse
of funds leading to financial distress.
Impact of Agency Costs on
Capital Structure
• Agency costs may be minimized by agreeing to include
several protective covenants in the bond contract
• Bond covenants impose costs (such as periodic disclosure)
and impose constraints (on the type of project
management can undertake, Collateral, distribution of
dividends, and limits on further borrowing)
• Thus agency costs of debt reduces the attractiveness of
debt and decreases the value of the firm.
• Figure 12-8 indicates the trade-offs. For example,
increasing the protective covenants will reduce the
interest cost but increase the monitoring cost (which
is eventually borne by the shareholders).
Summary of Capital Structure
Theory
• Market value of levered firm
= Market value of unlevered firm
+ Present value of tax shields
– Present value of Financial distress costs
– Present value of agency costs
7. Capital Structure Management
WACC
70%
0
80%
90%
100%
20%
30%
40%
50%
10%
60%
63
WACC and Debt Ratios
Weighted Average Cost of Capital and Debt Ratios
Debt Ratio
9.80%
9.60%
9.40%
11.40%
11.20%
11.00%
10.80%
10.60%
10.40%
10.20%
10.00%
Current Cost of Capital: Disney
• Equity
– Cost of Equity =
– Market Value of Equity =
– Equity/(Debt+Equity ) =
• Debt
– After-tax Cost of debt =
– Market Value of Debt =
– Debt/(Debt +Equity) =
13.85%
$50.88 Billion
82%
7.50% (1-.36) = 4.80%
$ 11.18 Billion
18%
• Cost of Capital = 13.85%(.82)+4.80%(.18) = 12.22%
Estimating Cost of Equity
Current Beta = 1.25
Unlevered Beta = 1.09
Market premium = 5.5%
T.Bond Rate = 7.00%
t=36%
Debt Ratio
0%0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
D/E Ratio
1.09
11%
25%
43%
67%
100%
150%
233%
400%
900%
Beta
13.00%
1.17
1.27
1.39
1.56
1.79
2.14
2.72
3.99
8.21
Cost of Equity
13.43%
13.96%
14.65%
15.56%
16.85%
18.77%
21.97%
28.95%
52.14%
Estimating Cost of Debt
Step
1
2
D/(D+E)
D/E
$ Debt
EBITDA
Depreciation
EBIT
$5,559
Interest
Taxable Income
Tax
0.00%
0.00%
$0
$6,693
$1,134
$5,559
$0
$5,559
$2,001
10.00%
11.11%
$6,207
$6,693
$1,134
$447
$5,112
$1,840
Calculation Details
= [D/(D+E)]/( 1 -[D/(D+E)])
= [D/(D+E)]* Firm Value
Kept constant as debt changes.
= Interest Rate * $ Debt
= EBIT – Interest
= Tax Rate * Taxable Income
Net Income $3,558
$3,272
= Taxable Income – Tax
Pre-tax Int. cov
∞
12.44
= EBIT/Int. Exp
3
Likely Rating AAA
AAA
Based upon interest coverage
4
Interest Rate
7.20%
7.20%
Interest rate for given rating
5
Eff. Tax Rate 36.00%
After-tax kd 4.61%
36.00%
4.61%
See notes on effective tax rate
=Interest Rate * (1 – Tax Rate)
Firm Value = 50,888+11,180= $62,068
66
The Ratings Table
If Interest Coverage
Ratio is
> 8.50
6.50 – 8.50
5.50 – 6.50
4.25 – 5.50
3.00 – 4.25
2.50 – 3.00
2.00 – 2.50
1.75 – 2.00
1.50 – 1.75
1.25 – 1.50
0.80 – 1.25
0.65 – 0.80
0.20 – 0.65
< 0.20
Estimated
Bond Rating
AAA
AA
A+
A
A–
BBB
BB
B+
B
B –
CCC
CC
C
D
Default
spread
0.20%
0.50%
0.80%
1.00%
1.25%
1.50%
2.00%
2.50%
3.25%
4.25%
5.00%
6.00%
7.50%
10.00%
A Test: Can you do the 20% level?
20.00%
Second Iteration
D/(D+E)
D/E
$ Debt
EBITDA
Depreciation
0.00%
0.00%
$0
$6,693
$1,134
10.00%
11.11%
$6,207
$6,693
$1,134
EBIT $5,559
$5,559
Interest Expense
Pre-tax Int. cov
Likely Rating
Interest Rate
Eff. Tax Rate
Cost of Debt
$0
∞
AAA
7.20%
36.00%
4.61%
$447
12.44
AAA
7.20%
36.00%
4.61%
Disney’s Cost of Capital Schedule
Debt Ratio
0.00%
10.00%
20.00%
30.00%
40.00%
50.00%
60.00%
70.00%
80.00%
90.00%
Cost of Equity
13.00%
13.43%
13.96%
14.65%
15.56%
16.85%
18.77%
21.97%
28.95%
52.14%
AT Cost of Debt
4.61%
4.61%
4.99%
5.28%
5.76%
6.56%
7.68%
7.68%
7.97%
9.42%
Cost of Capital
13.00%
12.55%
12.17%
11.84%
11.64%
11.70%
12.11%
11.97%
12.17%
13.69%
8. Capital Structure Management
(Survey Results)
The Ten Factors
•
A survey of 392 corporate executives reveals the
following ten factors as important determinants of
capital structure decision:
1.
Financial flexibility :
•
Firm’s bargaining position is better if it has choices
2.
Credit Rating:
•
Downgrading of credit rating will increase borrowing costs and
thus managers try to avoid anything that will trigger credit
downgrades
The Ten Factors
3.
Insufficient internal funds :
•
Firms follow a pecking order for raising funds – internal
funds followed by debt and then equity.
4.
Level of interest rates :
•
Firms tend to borrow when interest rates are low
relative to their expectations
5.
Interest tax savings
The Ten Factors
6.
Transaction costs and fees :
•
Cost of issuing equity is relatively higher than debt, making
equity a less attractive source.
7.
Equity valuation :
•
If shares are undervalued, firms will like to issue debt, and vice
versa.
8.
Competitor:
•
Firms from similar businesses tend to have similar capital
structures.
The Ten Factors
9.
Bankruptcy/distress costs :
•
Higher existing debt will increase the likelihood of financial
distress.
10.
Customer/supplier discomfort :
•
High levels of debt will increase discomfort among customers
(fearing disruption in supply) and suppliers (fearing disruption in
demand and late/non payment on existing contracts).
9. Finance and the Multinational Firm
Finance and the Multinational Firm:
Business Risk and Global Sales
Business risk is both multidimensional and
international, and is affected by:
1. The sensitivity of the firm’s product demand to
general economic conditions
2. The degree of competition to which the firm is
exposed
3. Product diversification
4. Growth prospects, and
5. Global sales volumes and production output.
Dividend Policy and Internal
Financing
Learning Objectives
1.
2.
3.
4.
Describe the trade-off between paying dividends and
retaining the profits within the company
Explain the relationship between a corporation’s dividend
policy and the market price of its common stock
Describe practical considerations that may be important to
the firm’s dividend policy
Distinguish among the types of dividend policies
corporations frequently use.
Learning Objectives
5. Specify the procedures a company follows in administering
the dividend payment.
6. Describe why and how a firm might pay noncash dividends
(stock dividends and stock splits) instead of cash dividends.
7. Explain the purpose and procedures related to stock
repurchases.
8. Understanding the relationship between a policy of low-
dividend payments and international capital budgeting
opportunities that confront the multinational firm.
Slide Contents
1. Principles Used in this Chapter
2. Dividends
3. Dividend Policy and Shareholder Wealth
4. Conclusions on Dividend Policy
5. Dividend Decision in Practice
6. Stock Dividend/Split/Repurchase
7. Finance and the Multinational Firm
Principles used in this Chapter
Principle 2:
The time value of money – A dollar received today is worth more
than a dollar received in the future.
Principle 8:
Taxes bias business decisions
What are Dividends?
Dividends are distribution from the firm’s assets
to the shareholders.
Firms are not obligated to pay dividends or
maintain a consistent policy with regard to
dividends.
Dividends can be paid in cash or stocks.
Dividend Policy
A firm’s dividend policy includes two
components:
1. Dividend Payout ratio
•
•
Indicates amount of dividend paid relative to the company’s
earnings.
Example: If dividend per share is $1 and earnings per share is
$2, the payout ratio is 50% (1/2)
2. Stability of dividends over time
Dividend Policies Vary
General Electric (GE) has paid dividends
continuously since 1899.
Microsoft (MSFT) went public in 1986 but did not
pay dividends until June, 2003.
Berkshire Hathaway (BRK) has not yet paid
dividends.
Dividend Policy Trade-offs
If management has decided how much to invest and
has chosen the debt-equity mix, decision to pay a
large dividend means retaining less of the firm’s
profits. This means the firm will have to rely more
on external equity financing.
Similarly, a smaller dividend payment will lead to
less reliance on external financing.
3. Dividend Policy and
Shareholder’s Wealth
Dividend Policy and
Share Prices
Dividend policy is considered as a puzzle with no
clear answers. As Fischer Black concluded more than
30 years ago:
“What should the individual investor do about dividends
in the portfolio? We don’t know!
What should the corporation do about dividend policy?
We don’t know!”
Three Views
There are three basic views with regard to the
impact of dividend policy on share prices:
1.
2.
3.
Dividend policy is irrelevant.
High dividends will increase share prices.
Low dividends will increase share prices.
View #1
Dividend policy is irrelevant –
Irrelevance implies shareholder wealth is not affected by
dividend policy (whether the firm pays 0% or 100% of its
earnings as dividends).
This view is based on two assumptions:
(a) Perfect capital markets exist; and
(b) The firm’s investment and borrowing decisions have been
made and will not be altered by dividend payment.
View #2
High dividends increase stock value –
This position in based on “bird-in-the-hand theory”,
which argues that investors may prefer “dividend today”
as it is less risky compared to “uncertain future capital
gains”.
Thus shareholders will demand a relatively higher rate of
return for stocks that do not pay low or no dividends.
View #3
Low dividends increases stock value –
In 2003, the tax rates on capital gains and dividends were made
equal to 15 percent.
However, current dividends are taxed immediately while the tax
on capital gains can be deferred until the stock is actually sold.
Thus, using present value of money, capital gains have definite
financial advantages for shareholders.
Thus stocks that allow tax deferral (low dividends-high capital
gains) will possibly sell at a premium relative to stocks that
require current taxation (high dividends – low capital gains).
Some other explanations
1. Residual Dividend theory
2. Clientele effect
3. Information effect
4. Agency costs
5. Expectations theory
Residual Dividend Theory
1. Determine the optimal capital budget.
2. Determine the amount of equity needed for financing.
3. First, use retained earnings to supply this equity.
4. If RE still left, pay out dividends.
Dividend Policy will be influenced by:
(a) investment opportunities or capital budgeting needs, and
(b) availability of internally generated capital.
The Clientele Effect
Different groups of investors have varying preferences
towards dividends.
For example, some investors may prefer a fixed income
stream so would prefer firms with high dividends while
some investors, such as wealthy investors, would prefer
to defer taxes and will be drawn to firms that have low
dividend payout. Thus there will be a clientele effect.
The Information Effect
Evidence shows that large, unexpected change in dividends
can have a significant impact on the stock prices.
A firm’s dividend policy may be seen as a signal about firm’s
financial condition. Thus, high dividend could signal
expectations of high earnings in the future and vice versa.
Agency Costs
Dividend policy may be perceived as a tool to minimize
agency costs.
Dividend payment may require managers to issue stock to
finance new investments. New investors will be attracted
only if they are convinced that the capital will be used
profitably. Thus, payment of dividends indirectly monitors
management’s investment activities and helps reduce agency
costs, and may enhance the value of the firm.
Expectations Theory
Expectation theory suggests that the market reaction
does not only reflect response to the firm’s actions; it
also indicates investors’ expectations about the ultimate
decision to be made by management.
Thus if the amount of dividend paid is equal to the
dividend expected by shareholders, the market price of
stock will remain unchanged. However, market will react
if dividend payment is not consistent with shareholders
expectations.
4. Conclusions on Dividend Policy
What are we to conclude?
Here are some conclusions about the relevance
of dividend policy:
1.
2.
As a firm’s investment opportunities increase, its dividend
payout ratio should decrease.
Investors use the dividend payment as a source of information
of expected earnings.
What are we to conclude?
3.
4.
5.
Relationship between stock prices and dividends may exist due to
implications of dividends for taxes and agency costs.
Based on expectations theory, firms should avoid surprising
investors with regard to dividend policy.
The firm’s dividend policy should effectively be treated as a long-
term residual.
5. Dividend Decision in Practice
Dividend Decision in Practice
Legal Restrictions
Statutory restrictions may prevent a company from
paying dividends
Debt and preferred stock contracts may impose
constraints on dividend policy
Liquidity Constraints
A firm may show earnings but it must have cash to pay
dividends.
Dividend Decision in Practice
Earnings Predictability
A firm with stable and predictable earnings is more
likely to pay larger dividends.
Maintaining Ownership Control
Ownership of common stock gives voting rights. If
existing stockholders are unable to participate in a
new offering, control of current stockholders is
diluted and issuing new stock will be considered
unattractive.
Alternative Dividend Policies
Constant dividend payout ratio
The % of earnings paid out in dividends is held
constant.
Since earnings are not constant, the dollar amount of
dividend will vary every year.
Stable dollar dividend per share
This policy maintains a constant dollar every year.
Management will increase the dollar amount only if
they are convinced that such increase can be
maintained.
Alternative Dividend Policies
A small regular dividend plus a year-end
extra.
The company follows the policy of paying a
small, regular dividend plus a year-end extra
dividend in prosperous years.
Dividend Payment Procedures
Generally, companies pay dividend on a quarterly
basis. The final approval of a dividend payment
comes from the firm’s board of directors.
For example, GE pays $6.72 per share in annual
dividend in four equal installments of $1.68 each.
Important Dates
Declaration date – The date when the dividend is formally
declared by the board of directors. (Ex. February 7)
Date of Record – Investors shown to own stocks on this date
receive the dividend. (Ex. February 17)
Ex-Dividend date – Two working days prior to date of record
(Ex. February 15). Shareholders buying stock on or after ex-
dividend date will not receive dividends.
Payment date – The date when dividend checks are mailed.
(ex. March 10)
6. Stock Dividends, Stock Splits and
Stock Repurchase
Stock Dividends
A stock dividend entails the distribution of
additional shares of stock in lieu of cash payment.
While the number of common stock outstanding
increases, the firm’s investments and future
earnings prospects do not change.
Stock Split
A stock split involves exchanging more (or less in the case of
“reverse” split) shares of stock for firm’s outstanding shares.
While the number of common stock outstanding increases
(or decreases in the case of reverse split), the firm’s
investments and future earnings prospects do not change.
Stock splits and stock dividends are far less frequent than
cash dividends.
Stock Repurchase
A stock repurchase (stock buyback) occurs when a
firm repurchases its own stock. This results in a
reduction in the number of shares outstanding.
From shareholder’s perspective, a stock repurchase
has potential tax advantages as opposed to cash
dividends.
Stock Repurchase – Benefits
1.
2.
3.
4.
5.
6.
A means of providing an internal investment opportunity
An approach for modifying the firm’s capital structure
A favorable impact on earnings per share
The elimination of a minority ownership group of
stockholders
The minimization of the dilution of earnings per share
associated with mergers
The reduction in the firm’s costs associated with servicing
small stockholders
Stock Repurchase Procedure
1. Open Market – Shares are acquired from a
stockbroker at the current market price.
2. Tender Offer – An offer made by the company to
buy a specified number of shares at a
predetermined price, set above the current market
price.
3. Purchase from one or more major stockholders.
7. Finance and
the Multinational Firm
Finance and the
Multinational Firm
During general economic prosperity, the
multinational firms look towards international
markets for high NPV projects for two reasons:
To reduce country related economic risk by diversifying
geographically; and
To achieve a cost advantage over one’s competitors.
