Financial Management

Topic 7: Dividends
2022
Tulane – MBA UChile

Helmuth Chavez (hchaveza@tulane.edu)

Tulane, Financial Management, 2022 Topic: Dividends

Tulane, Financial Management, 2022 Topic: Dividends
 What is the impact of the dividend
policy on Enterprise Value (EV)?

Are dividend paying firms worth more?

Is there an optimal dividend payout

ratio?

Tulane, Financial Management, 2022 Topic: Dividends

 MODIGLIANI Y MILLER

The dividend policy (i.e. Payout ratio) is irrelevant for the

shareholders (under perfect markets model)

What is “Dividend Policy” under M&M?

• M&M assume a dividend payment “ceteris paribus”, e.g.

Without any other change (including changes in investments
and capital structure)

• Methodologically, we need to pay a dividend without any other

change. Only by doing this we could isolate the effect of
dividends to understand it.
Tulane, Financial Management, 2022 Topic: Dividends
 M&M Dividend Policy

The only way to pay a dividend without changing the

investment plans and the capital structure is issuing new
shares keeping equity constant. This implies that the
money form the new equity issuance is used to pay the
dividend

Example:

Tulane, Financial Management, 2022 Topic: Dividends

 Example: Dividend Policy

r= 10%
pt= $50 (price per share)
nt= 300 (number of outstanding shares)
It+1= $2,000 (next period Capex)
Xt+1= $1,500 (nex period cash from operations)

• CASE A: dt+1= $ 1 per share

• CASE B: dt+1= $ 2 per share

Analyze the price per share and EV at t=0 and t=1

Tulane, Financial Management, 2022 Topic: Dividends

 Shareholders earn returns from two sources:

• Dividends (D)
• Capital Gains = Pt – Pt-1

Tulane, Financial Management, 2022 Topic: Dividends

 CASE A: dt+1= $ 1 per share
Dt 1  pt 1  pt $1  pt 1  $50
r  10%   pt 1  $54
pt $50
How many new shares do we have to issue to have the funds
needed for new Capex It+1?

Available cash flows It+1 = outflows It+1

Available CF: Cash flow from operations Xt+1: $1,500
Issuance of new shares: (mt+1)(pt+1)=mt+1*54
Outflows: CAPEX: It+1=$2,000
Dividends: Dt+1=$300

• Estimate EV at t and t+1

Tulane, Financial Management, 2022 Topic: Dividends

 CASE A: dt+1= $ 2 per share
Dt 1  pt 1  pt
r  10%
pt
How many new shares do we have to issue to have the funds
needed for new Capex It+1?

Available cash flows It+1 = outflows It+1

Available CF: Cash flow from operations Xt+1: $1,500
Issuance of new shares: (mt+1)(pt+1)=mt+1*53
Outflows: CAPEX: It+1=$2,000
Dividends: Dt+1=$600

• Estimate EV at t and t+1

Tulane, Financial Management, 2022 Topic: Dividends

 Case A Case B
dt+1 $1 $2
pt $50 $50
pt+1 $54 $53
Capital Gains $4 $3
mt+1 14.8 shares at 20.75 shares
$54 at $53
Issuance $ $800 $1,100
EVt $15,000 $15,000
EVt+1 $17,000 $17,000

Tulane, Financial Management, 2022 Topic: Dividends

 The impact of a dividend payment is that it decreases the share
price (and hence capital gains) in the same amount.

d t 1  pt 1  pt
r
pt

Tulane, Financial Management, 2022 Topic: Dividends

 DIVIDEND DISCOUNT MODEL (Gordon´s Model)

The Equity value is given by:

d
E
ke
And if dividends grow at a constant rate:

d
E
ke  g
Tulane, Financial Management, 2022 Topic: Dividends
 DIVIDEND DISCOUNT MODEL

Example

ABC will pay an annual dividend of $5 per share (the first payment
will be in one year). Dividens are expected to grow ath 3% per
year. If the Ke is 12%, waht is the share price?

Tulane, Financial Management, 2022 Topic: Dividends

 Dividends

EXERCISE:

DIVIDEND DISCOUNT MODEL

RELATION BETWEEN GROWTH AND EV

Excel File: 2022, Tulane, FM, Worksheet 16, Dividends

Tulane, Financial Management, 2022 Topic: Dividends

 Dividend Discount Model

• “g” is the growth rate of the dividends

• “g” depends on the ROE and the dividend Payout Rate “d”

Tulane, Financial Management, 2022 Topic: Dividends

 Growth and Enterprise Value

• If a firm has a dividend payout rate of 100%, its retained

earnings are zero and hence the growth rate is 0%.

• Retained earnings generate growth, hence the higher

the dividend payout ratio the lower the growth rate

• What is not so clear is the relation between gowth and

Enterprise Value

Tulane, Financial Management, 2022 Topic: Dividends

Tulane, Financial Management, 2022 Topic: Dividends
Tulane, Financial Management, 2022 Topic: Dividends
 Firm A grows and Firm B doesn´t and both have
the same EV ($100)

Tulane, Financial Management, 2022 Topic: Dividends

 Firm A grows and Firm B doesn´t and both have
the same EV ($100); Firm C doesn´t grow and has
A higher value than B and even than A (that grows)

Tulane, Financial Management, 2022 Topic: Dividends

 C, D and E have the same ROE (12%), and firm D has the
highest EV. Firm E and A have the same “g” (6%) and
firm E has a higher EV.

Tulane, Financial Management, 2022 Topic: Dividends

Tulane, Financial Management, 2022 Topic: Dividends
 CONCLUSION

• Gowth generates value (higher Evs) only if the actual

return is higher than the cost of capital (i.e. Only if the
EVA is positive)

• Firms that generate a higher return than similar

investments (i.e. Positive EVA) should not pay dividends

Tulane, Financial Management, 2022 Topic: Dividends

 Dividends

EXERCISE:

DIVIDEND DISCOUNT MODEL

Excel File: ASSINGMENT, 2022, Tulane, FM, Dividends

Tulane, Financial Management, 2022 Topic: Dividends