Financial Decisions. 8b Dividend Policy in practice. 1. Constant Payout Dividende stable 2. Pure Residual Distribution Residuelle

Transcription

1 Financial Decisions 8b Dividend Policy in practice 1. Constant Payout Dividende stable 2. Pure Residual Distribution Residuelle 3. Smoothed Residual lisse Distribution résiduelle 4. Target Payout Distribution cible Instructor: A. Ashta References: Ross, Westerfield Jordan: Ch. 14 Emery, Finnerty & Stowe: Ch. 17 Brealey and Myers: «Principes de gestion financière» Ch. 16 1

2 Dividend Policy in Practice Regular decisions Review dividend policy at least annually, and at about the same time each year. Regular payments Quarterly payments most common. Annual, semi-annual, and monthly payments are less common. 2

3 Dividend Policy in Practice Reluctance to cut dividends Dividend cut is interpreted as a negative signal. Extra or special dividends Paid during periods of temporarily high earnings. Generally occur at the end of the fiscal year. Réticence de réduire les dividendes Une baisse de Dividende est aperçu comme un signal négatif Dividendes bonu ou extraordinaire Payé dans les périodes de résultat temporairement haut Normalement en fin d année fiscale 3

4 1. Constant Payout Could be Constant Dividends Could be Constant Pay-Out Ratio (POR) POR = Dividends / Earnings After Tax 4

5 Simple application: Emery Ch. 17 Q. A1 ESPL has the following quarterly EPS and has paid a regular quarterly dividend of $0.30. Quarter Total Earnings per share ($) Dividends per share ($) ESPL wants the annual payout to be 40% of earnings. What extra dividend would give the firm its planned payout? 5

6 Applying the Dividend Policy Guidelines The Bondex Paper Co. (BPC) has 10 million shares outstanding. During 2002, it earned $40 million and paid out $1.20 per share in dividends. You are given the forecasts of earnings, depreciation funds, and capital expenditures for Evaluate the following three dividend policies and make a recommendation. Maintain the 2002 dividend amount. Maintain the 2002 payout ratio. Increase the dividend to $1.60 per share effective

7 Bondex Paper Co. (BPC): Residual Funds Earnings to common Depreciation funds Capital expenditures $50 $12 $45 $60 $14 $54 $67 $18 $74 Residual Funds $17 $20 $11 Note: All dollar values are in millions. 7

8 BPC: Maintain Current Dividend Earnings to common* Earnings per share Dividend per share Payout ratio Total dividends* Retained Earnings* * In Millions of dollars Residual funds Dividend Surplus/ Deficit 8

9 BPC: Maintain Current Payout Ratio Earnings to common* Earnings per share Dividend per share Payout ratio Total dividends* Retained Earnings * * In Millions of dollars Residual funds Dividend Surplus/ Deficit 9

10 BPC: Increase Dividend to $1.60 Earnings to common* Earnings per share Dividend per share Payout ratio Total dividends* Retained Earnings * * In Millions of dollars Residual funds Dividend Surplus/ Deficit 10

11 Applying the Dividend Policy Guidelines Dividend Policy Maintain DPS Maintain POR DPS of $1.60 Average Payout Ratio Total Surplus Funds 11

12 2. Pure Residual Policy Consider investment needs: positive NPV projects Consider target D/E ratio Rest can be given as dividends Dividends fluctuate from year to year 12

13 The Residual Dividend Approach The Residual Dividend Approach Net income (projected) = $200M D/E (target) = 2/3 (E/V = %; D/V = %) Capital budget (planned) = $260 million Maximum capital spending with no outside equity:.60 X = $200M X = $ million So, a dividend will be paid New equity needed =.60 $260M = $ New debt needed =.40 $260M = $ Dividend = $ - $156 million= $ 13

14 3. Smoothed Residual Policy (based on Long-term) Need to smoothen dividend payments (especially avoid cuts) Increase or decrease only if you are sure to be able to maintain new levels Let D/E ration vary cyclically or in the ST Payout ratio varies: lower when earnings are high 14

15 A Dividend Adjustment Model Managers frequently believe that the firm should aim towards a long-term target payout ratio. If the payout ratio is held constant in every period, the dividends would fluctuate as earnings fluctuate from yearto-year. A partial adjustment model can be used to smooth out these dividends fluctuations. 15

16 A Dividend Adjustment Model Let EPS t = the firm s earnings in period t. DPS t = the dividend in period t. POR = target payout ratio. ADJ = dividend adjustment factor. DPS [ POR ( EPS ) ] 1= DPS 0 + ADJ 1 DPS 0 16

17 A Dividend Adjustment Model The Dannon Yogurt Co. has historically paid out 40% of its earnings as dividends. Dannon earned $5 per share last year and is expected to earn $6 per share by the end of this year. Future earnings per share are expected to remain at this new level. Dannon s treasurer has applied an adjustment model factor of Forecast Dannon s future dividends. 17

18 A Dividend Adjustment Model DPS 0 = POR(EPS 0 ) = 1 0 [ POR( EPS ) ] DPS = DPS + ADJ DPS 1 0 = $ = $ 18

19 A Dividend Adjustment Model DPS 2 1 [ POR ( EPS ) ] = DPS + ADJ DPS 1 1 = $ = $ 19

20 A Dividend Adjustment Model $2,4 DPS $2,2 $2,0 $1, Year 20

21 Dividend Policies in Practice Most US companies tend to follow the smoothed residual approach. Dividend cuts are infrequent. After-tax earnings are more volatile than dividends. Dividend changes lag earnings changes. 21

22 4. Target Payout Project future residual funds. Earnings and cash flow projections for the next few years. Include depreciation generated funds Adjust for change in working capital Deduct capital expenditures Determine an appropriate target payout ratio. Range of payout ratios. Set the quarterly dividend. Evaluate alternative dividend policies. 22

23 The Best of All Worlds? Establishing a Compromise Dividend Policy Avoid rejecting +NPV projects to pay a dividend Avoid cutting dividends Avoid issuing new equity Maintain target debt-equity ratio Maintain target dividend payout ratio 23

24 Industry Differences in Dividend Policy Payout ratios vary systematically across industries. Investment opportunities are comparable within an industry, but vary across industries. Behavioral principle suggests using payout ratios similar to those of other firms in the industry. Firm-specific information must be taken into account. 24

25 Industry Differences in Dividend Policy Industry Building materials Drugs & health care Textiles Business equipment Oil Chemicals Electric utilities Payout Ratio % 7.8% 18.3% 22.1% 22.1% 31.5% 74.3% 25

26 Quick Quiz 1. Under what conditions would managers decide to issue an extra cash dividend? 2. Why does the price of a share of dividend-paying stock fall on the ex-dividend date? 3. What are the implications of the clientele effect for those who set the firm s dividend policy? 4. What are the implications of the information content effect for those who set the firm s dividend policy? 26