Dividend Policy

Kiran Thapa

Topics

Nature of dividend policy

Payment procedure
Types of dividend policies
Determinants of dividend policy
Cash dividend and stock dividends
Stock splits and reverse splits
Repurchase of stocks

Nature of dividend policy

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.

Payment Procedure

Declaration 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.

Types of dividend Policy

Constant dividend per share

Constant dividend payout ratio

Low regular dividends plus extras

Residual dividend policy

Residual Dividend Policy

Determine optimal capital budget

Determine the amount of equity required to
finance the capital budget.
Use retained earnings
Pay dividends after the investing in capital
budget
Dividends =Net income (capital budget equity ratio)

Determinants of dividend policy

Size of the earnings

Liquidity position
Legal rules
Desire of shareholders
Restrictions in debt contracts
Rate of asset expansion
Access to the capital markets

Forms of Dividends

Cash 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.

Stock dividend contd.

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 shareholders

Stock dividend contd.

Advantages
- Tax benefits
- Indication of higher future profits
- Future dividends may increase
- Psychological value
Disadvantages
- More costly
- Wealth remains unaffected
- Problem of adjusting EPS and P/E ratio

Stock split vs Reverse Split

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.

Reverse split
Used to increase the price of the stock
Decrease the number of shares.
Increase the market price
Increase par value
Net worth remains the same.
For example, 1 for 2, 1 for 3 etc.

Stock Repurchase

Buying own stock back from stockholders

Also known as Treasury stock or acquire stock

Reasons 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

Method of repurchase

Open market
Tender offer
Negotiation basis
Calculation of repurchase price
Repurchase price = MPS before repurchase /(1
number of shares repurchased in fraction)

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 2
a. 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 3
A 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 4
Zoppo Manufacturers shareholders' equity Dec.30, 19X1:
Common stock (Rs.100 par, 300,000 shares) = Rs.30,000,000
Additional paid in capital
= Rs.15,000,000
Retained earnings
= Rs.55,000,000
Shareholders' 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 5
Beta 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?