DIVIDENDS, SHARE REPURCHASES

AND OTHER PAYOUTS

 Stock Returns

Return = P1 - Po + D1
Po

P1 - Po D1
= +
Po Po
 Stock Returns

Return = P1 - Po + D1
Po

P1 - Po D1
= +
Po Po

Capital Gain
 Recall: Stock Returns

Return = P1 - Po + D1
Po

P1 - Po D1
= +
Po Po

Capital Gain Dividend Yield

 Recall: Stock Returns

Return = P1 - Po + D1
Po

50 - 40 4
= +
40 40

Capital Gain Dividend Yield

25% + 10% = 35%
 WHAT ARE DIVIDENDS?
A dividend is a distribution of earnings to
shareholders, generally paid in the form of cash
or stock.

The portion of after-tax earnings not paid out as

dividends is called RETAINED EARNINGS.

Dividend-payout ratio is the percentage of

earnings paid to shareholders in cash.
 WHAT ARE THE ADVANTAGES
OF PAYING DIVIDENDS?
1. underscore good results and provide support to
the equity share price.
2. attract investors who prefer some returns in the
form of dividends
3. Equity share price usually increases with the
announcement of a new or increased dividend.
4. absorb excess cash flow and reduce agency cost
that arise from conflicts between management
and shareholders.
 Paying dividends reduces retained earnings
and forces the firm to raise external equity
financing.

 Raising external equity subjects the firm to

scrutiny of regulators (SEC) and investors
and therefore helps monitor the
performance of managers.
 WHAT ARE THE DISADVANTAGES
OF PAYING DIVIDENDS?
1. Dividends are taxable to the recipients.
2. Dividends reduce internal sources of
financing.
3. Once established, dividend cuts are hard to
make without adversely affecting a firm’s
share price.
 Dilemma: Should the firm use
retained earnings for:

a) Financing profitable capital

investments that will result to
CAPITAL GAINS?
b) Paying dividends to stockholders?
 Why do some investors favor
CAPITAL GAINS?

Reason:
 Dividends are taxed immediately.
Capital gains are not taxed until the
stock is sold.
 Therefore, taxes on capital gains can
be deferred indefinitely.
 So, dividend policy really
involves 2 decisions:
 How much of the firm’s earnings
should be distributed to
shareholders as dividends, and
 How much should be retained for
capital investment.
 Is Dividend Policy Important?

Three viewpoints:
1) Dividend Policy Irrelevance Theory
If we assume perfect markets (no taxes,
no transactions costs, etc.) dividends do
not matter.
If we pay a dividend, shareholders’
dividend yield rises, but capital gains
decrease.
 P1 - Po D1
Return = +
Po Po

 If we retain earnings for profitable

investments,
 P1 - Po D1
Return = +
Po Po

 If we retain earnings for profitable

investments, dividend yield will be zero,
 P1 - Po D1
Return = +
Po Po

 If we retain earnings for profitable

investments, dividend yield will be zero,
but the stock price will increase, resulting
in a higher capital gain.
 P1 - Po D1
Return = +
Po Po

 If we pay dividends,
 P1 - Po D1
Return = +
Po Po

 If we pay dividends, stockholders receive

an immediate cash reward for investing,
 P1 - Po D1
Return = +
Po Po

 If we pay dividends, stockholders receive

an immediate cash reward for investing,
but the capital gain will decrease, since
this cash is not invested in the firm.
 P1 - Po D1
Return = +
Po Po

 Dividend irrelevance: In perfect

markets, investors do not care if
returns come in the form of dividend
yields or capital gains.
 P1 - Po D1
Return = +
Po Po

 Dividend irrelevance: In perfect

markets, investors do not care if
returns come in the form of dividend
yields or capital gains.
 P1 - Po D1
Return = +
Po Po

 Dividend irrelevance: In perfect

markets, investors do not care if
returns come in the form of dividend
yields or capital gains.
 2) The Dividend Policy
Relevance Theory
 Some investors may prefer a certain
dividend now over a risky expected
capital gain in the future.
 2) The Dividend Policy
Relevance Theory
 Some investors may prefer a certain
dividend now over a risky expected
capital gain in the future.

P1 - Po D1
Return = +
Po Po

“bird-in-hand” theory
 2) The Dividend Policy
Relevance Theory
Information Effects:
 Raising a firm’s dividend usually causes
the stock price to rise and decreasing the
dividend causes the stock price to fall.
 Dividend changes convey information to
the market concerning the firm’s future
prospects.
 2) The Dividend Policy
Relevance Theory
 Investors form expectations concerning
the amount of a firm’s upcoming dividend.
 Expectations are based on past dividends,
expected earnings, investment and
financing decisions, the economy, etc.
 The stock price will likely react if the
actual dividend is different from the
expected dividend.
 2) The Dividend Policy
Relevance Theory
Clientele Effects:
 Different investor clienteles prefer different
dividend payout levels.
 Some firms, such as utilities, pay out over
70% of their earnings as dividends. These
attract a clientele that prefers high dividends.
 Growth-oriented firms which pay low (or no)
dividends attract a clientele that prefers price
appreciation to dividends
 3) Residual Theory of
Dividends Policy
 The firm pays a dividend only if it has
retained earnings left after financing all
profitable investment opportunities.

 This would maximize capital gains for

stockholders and minimize flotation
costs of issuing new common stock.
 3) Residual Theory of
Dividends Policy
 To illustrate:
 Your firm finances new investments by 35% debt and 65% equity. The firm
needs P700,000 for financing new investments. If retained earnings available
for reinvestment equal P425,000, how much money will be available for
dividends in accordance with the residual dividend theory?

Required financing 700,000

X 65%
Financed by stockholders 455,000 (will come from retained earnings)
Retained earnings-internal 425,000
Issue common stocks-external 30,000

No dividends will be paid. All retained earnings available are used for financing new investment.
 
 3) Residual Theory of
Dividends Policy
 Another illustration:
 Your firm finances new investments by 70% debt and 30% equity. The firm
needs P1,200,000 for financing new investments. If retained earnings
available for reinvestment equal P450,000, how much money will be available
for dividends in accordance with the residual dividend theory?

Required financing 1,200,000

X 30%
Financed by stockholders 360,000 (will come from retained earnings)
Retained earnings available 450,000
Excess- declare as dividends 90,000
 Dividend Policies
1) Stable Dividend Policy: is
characterized by the tendency to keep a
stable peso amount of dividend per share
period to period.
 firms and stockholders prefer stable
dividends.
 Decreasing the dividend sends a negative
signal!
Illustration:
STABLE DIVIDEND
POLICY
 Lorelie Products, Inc. earned P4,000,000 last
year and paid P1.40 per share dividends on
1M outstanding shares.
 Because of a temporary slump in the market,
the firm expects to earn P3.6M this year.
 Under the stable dividend policy, the
company will maintain a P1.40 DPS despite
the expected decline in earnings.
 Dividend Policies

2) Constant Dividend Payout Ratio Policy :

 if directors declare a constant payout ratio of,
for example, 30%, then for every peso of
earnings available to stockholders, 30
centavos would be paid out as dividends.

 the ratio remains constant over time, but

the peso value of dividends changes as
earnings change.
Illustration:
CONSTANT DPR POLICY
 Using the same data of Lorelie products:
 Lorelie Products, Inc. earned P4,000,000 last year and paid
P1.40 per share dividends on 1M outstanding shares.
 Dividends last year = P1.40 x 1M shares= P1,400,000
 DPR = Dividends/Earnings DPR = DPS/EPS
 = 1,400,000/4,000,000 = 1.40/ 4.00
= 35%
 = 35%
 The firm expects to earn P3.6M this year.
 Under the constant DPR policy,
 Dividend this year is (35% x P3,600,000)= P1,260,000
 Dividend per share is (P1,260,000/1M shares) = P1.26
 Dividend Policies
3) Regular Dividends plus Extras Policy
 the firm pays a low but stable regular dividend
and includes an extra year-end dividend in
prosperous years.

 By identifying the year-end dividend as

“extra,” directors hope to avoid signaling
that this is a permanent dividend.
 A compromise between the previous 2 policies.
 Dividend Policies
3) Regular Dividends plus Extras Policy
Illustration:
The earnings for Carlo Cargi Inc. have been predicted for the next 5 years and are listed
below.
Year Profits After TaxesRegular Extra
1 P1,500,000 Dividend Dividend
2 P2,000,000 P0.50 -0-
3 P1,750,000 P0.50 P0.25 50%(2M – 1.5M)/1,000,000 shares
4 P 950,000
P0.50 P0.125 50%(1.75M – 1.5M)/1,000,000 share
5 P2,500,000
P0.50 -0-
 P0.50 P0.50
There are 1,000,000 shares outstanding. Determine the50%(2.5M – 1.5M)/1,000,000
yearly dividend per share to be paid shares
if
the following policies are enacted:
 Small, regular dividend of P.50 per share plus a year-end extra when the profits in any year
exceed P1,500,000. The year-end extra dividend will equal 50% of profits exceeding
P1,500,000.
  Compute the DIVIDEND PER SHARE FOR EACH YEAR.
 Dividend Policies
3) Regular Dividends plus Extras Policy
Illustration:
The earnings for Carlo Cargi Inc. have been predicted for the next 5 years and are listed
below.
Year Profits After TaxesRegular Extra Total Dividend
1 P1,500,000 Dividend Dividend Per Share
2 P2,000,000 P0.50 -0- P0.50
3 P1,750,000 P0.50 P0.25 P0.75
4 P 950,000
P0.50 P0.125 P0.625
5 P2,500,000
P0.50 -0- P0.50
 P0.50
There are 1,000,000 shares outstanding. DetermineP0.50 P1.00
the yearly dividend per share to be paid if
the following policies are enacted:
 Small, regular dividend of P.50 per share plus a year-end extra when the profits in any year
exceed P1,500,000. The year-end extra dividend will equal 50% of profits exceeding
P1,500,000.
  
 TYPES OF
DIVIDENDS
A. CASH DIVIDENDS -the most common type of dividend

1. Regular Dividend -paid quarterly

2. Extra Dividend -may not be repeated in the future
3.Special Dividend -unusual or one-time event
4.Liquidating Dividend -given once company is sold-off
B. STOCK DIVIDENDS
A proportional distribution by a corporation of its own stock to its
stockholders.
Example: a 20% stock dividend means a shareholder receives one
new share for every 5 currently owned shares (a 20% increase).
Stock dividends do not transfer the corporation’s assets to the Stockholders.
 Jan.4 Jan.28 Feb.1 Mar. 11
Declare Ex-div. Record Payment
dividend date date date
Dividend Payments
1) Declaration Date: the board of
directors declares the dividend,
determines the amount of the dividend,
and decides on the payment date.
 Jan.4 Jan.28 Feb.1 Mar. 11
Declare Ex-div. Record Payment
dividend date date date
Dividend Payments
2) Ex-Dividend Date:
 Jan.4 Jan.28 Feb.1 Mar. 11
Declare Ex-div. Record Payment
dividend date date date
Dividend Payments
2) Ex-Dividend Date: To receive the
dividend, you have to buy the stock before
the ex-dividend date. On this date, the
stock begins trading “ex-dividend” and
the stock price falls approximately by the
amount of the dividend.
 Jan.4 Jan.28 Feb.1 Mar. 11
Declare Ex-div. Record Payment
dividend date date date
Dividend Payments
3) Date of Record:
 Jan.4 Jan.28 Feb.1 Mar. 11
Declare Ex-div. Record Payment
dividend date date date
Dividend Payments
3) Date of Record: 4 days after the ex-
dividend date, the firm receives the list of
stockholders eligible for the dividend.
 often, a bank trust department acts as
registrar and maintains this list for the
firm.
 Jan.4 Jan.28 Feb.1 Mar. 11
Declare Ex-div. Record Payment
dividend date date date
Dividend Payments
4) Payment Date: date on which the
firm mails the dividend checks to the
shareholders of record.
 To illustrate:
 Abbot Labs, on December 12, 2021, announced that holders of
record as of January 13, 2022 would receive a P100 dividend on
February 15.
 Declaration date?
 DECEMBER 12
 Date of Record?
 JANUARY 13
 Payment Date?
 FEBRUARY 15
 Ex-Dividend date?
 JANUARY 9
 Reasons for Stock Dividends

1. To continue dividends but conserve

cash.

2. To reduce the market price of its stock

on a per share basis.
ANSWER PROBLEMS in CHAPTER 20
Nos.
•1
•9
•10
•11
•13
•19
•20
ANSWER TO PROBLEMS No. 1
ANSWER TO PROBLEMS No. 9
ANSWER TO PROBLEMS No. 10
ANSWER TO PROBLEMS No. 11
ANSWER TO PROBLEMS No. 13
ANSWER TO PROBLEMS No. 19
ANSWER TO PROBLEMS No. 20
 Stock Dividends and Stock
Splits
 Stock Split: the firm increases the
number of shares outstanding and reduces
the price of each share.
 Example: Joule, Inc. announced a 3-for-2
stock split. For each 100 shares held,
shareholders received another 50 shares.
100 shares x 3/2= 150 shares
So, 100 will be 150 after a 3-for-2 stock split
or 50 additional shares.
 Stock Dividends and Stock Splits
 So if the firm has P100,000 common
stock, how much is the price per
share before the stock split?
 P100,000/100 shares= P1,000/share
 After the stock split?
 P100,000/150 shares=P666.67
 Stock Dividends and Stock Splits

 3-for-1 stock split?

 200 additional shares

 5-for-2 stock split?

 150 additional shares
 Stock Dividends and Stock Splits
 Does Stock split increase shareholder’s
wealth?:
 Stock split only increases the number
of shares outstanding and reduces the
price of each share. Total amount of
Common stock (P100,000) does not
change.

 Are Stock Split and Stock Dividend the

same?
 Stock Dividends and Stock
Splits
 Stock Splits and Stock Dividends are
economically the same: the number of
shares outstanding increases and the
price of each share drops. The value of
the firm does not change.
 Example: A 3-for-2 stock split is the
same as a 50% stock dividend. For each
100 shares held, shareholders receive
another 50 shares.
 Stock Dividends and Stock
Splits
 Effects on Shareholder Wealth:
 Stock Dividends and Stock
Splits
 Effects on Shareholder Wealth: these will
cut the company “pie” into more pieces
but will not create wealth. A 100% stock
dividend (or a 2-for-1 stock split) gives
shareholders 2 half-sized pieces for each
full-sized piece they previously owned.
 Stock Dividends and Stock
Splits
 Effects on Shareholder Wealth: these will
cut the company “pie” into more pieces but
will not create wealth. A 100% stock
dividend (or a 2-for-1 stock split) gives
shareholders 2 half-sized pieces for each
full-sized piece they previously owned.
 For example, this would double the number
of shares, but would cause a P60 stock price
to fall to P30.
 Stock Dividends and Stock
Splits
 Why bother?
 Proponents argue that these are used to
reduce high stock prices to a “more
popular” trading range (generally P15 to
P70 per share).
 Opponents argue that most stocks are
purchased by institutional investors who
have millions to invest and are indifferent
to price levels.
 Stock Dividend Example
 shares outstanding: 1,000,000
 net income = P6,000,000;
 Price-Earnings Ratio = 10
 25% stock dividend was declared
 An investor has 120 shares. Does the
value of the investor’s shares
change?
 Compute first for the EPS before
and after the 25% stock
dividend.
 Then compute for the total value
of stock (Price per share x no. of
shares)
Before the 25% stock dividend:
 EPS = 6,000,000/1,000,000 = 6
 Price/Earnings = P/6 = 10,
 so P = 60 per share.
 Value = 60 x 120 shares = 7,200

After the 25% stock dividend:

 # shares = 1,000,000 x 1.25 = 1,250,000.
 EPS = 6,000,000/1,250,000 = 4.80
 P/E = P/4.80 = 10, so P = 48 per share.
 Investor now has 120 x 1.25 = 150 shares.
 Value = 48 x 150 = 7,200
 YOUR TURN
 Common Stock (Php2 par, 100,000 shares)
P200,000
 A. A 15% stock dividend is issued
 B. A two-for-one stock split is declared
 Q: Compute for the no. of shares and the
stock price after stock split/dividend for
each case.
 Q: Does total value increase?
 ANSWER

 100,000 X 115% = 115,000 SHARES

 Php200,000/ 115,000=Php 1.74

 100,000 X 2/1= 200,000 SHARES

 Php200,000/200,000=Php1.00
 REVERSE SPLIT
- is done to decrease the number of shares
outstanding and is unusual.

Example:
H&M which has P5 par value stock could
split its stock 1 for 4.
After the split, par value would be P20
(P5x4).
 STOCK
REPURCHASE?
The repurchase or buy-back of common stock
by the issuing firm for any of a variety of
reasons resulting in a reduction of shares
outstanding.

Also known as treasury shares.

 Stock Repurchases

 Stock Repurchases may be a good

substitute for cash dividends.
 If the firm has excess cash, why not buy
back common stock?
 Stock Repurchases
 Repurchases drive up the stock price,
producing capital gains for shareholders.
 Repurchases increase leverage, and can
be used to move toward the optimal
capital structure.
 Repurchases signal positive information
to the market - which increases stock
price.
 Stock Repurchases
Methods:
 Buy shares in the open market through a
broker.
 Buy a large block by negotiating the
purchase with a large block holder,
usually an institution. (targeted stock
repurchase)
 Tender offer: offer to pay a specific price
to all current stockholders.
 Stock Repurchases
ILLUSTRATION
After repurchase
Before Repurchase
– Net Earnings P3,000,000 P3,000,000
– Shares outstanding 1,000,000 937,300 shares
– Earnings per Share (P3M/1M) P3 P3.20(3M/937,300)
– Price Earnings Ratio 10
– Market Price per share (P3x10) P30 P32 (P3.20x10)
– Expected Dividend P 2

The Company can use P2M excess cash either to pay P2 cash dividend per share
or to repurchase 62,700 shares at P32 each.

The wealth position would remain the same for each

alternative (P2 dividend or P2 increase in stock price).
 PROBLEM NO. 2
Ordinary Shares(P1 par) 30,000 30,000 +(3,000 sh x P1) = 33,000
Capital Surplus 285,000 285,000+ (3,000xP29)= 372,000
Retained Earnings 649,180 649,180 – (3,000 x P30)= 559,180
Total Owner’s Equity 964,180 964,180

a)If Trio stock currently sells for P30 per share and a
10% stock dividends is declared,
how many new shares will be distributed?
Show how the equity account would change.

Dr. Retained Earnings(3,000xP30) 90,000

No. of shares: Cr. Ordinary Shares (3,000xP1) 3,000
P30,000/P1 par = 30,000 shares Capital Surplus (3,000 x P29) 87,000

30,000 x 1.10 = 33,000 shares (or 3,000 new shares)

 PROBLEM NO. 2
Ordinary Shares(P1 par) 30,000 30,000 +(7,500 sh x P1) = 37,500
Capital Surplus 285,000 285,000+(7,500 x P29) 502,500
Retained Earnings 649,180 649,180 – (7,500 x P30)= 424,180
Total Owner’s Equity 964,180 964,180

b) Trio declares a 25% stock dividend, how would the accounts

change?
Dr. Retained Earnings(7,500xP30) 225,000
Cr. Ordinary Shares (7,500xP1) 7,500
Capital Surplus (7,500 x P29) 217,500

No. of shares:
P30,000/P1 par = 30,000 shares

30,000 x 1.25 = 37,500 shares (or 7,500 new shares)

 PROBLEM NO. 3
Ordinary Shares(P1 par) 30,000
Capital Surplus 285,000
Retained Earnings 649,180
Total Owner’s Equity 964,180

a)Trio declares a 4-for-1 stock split. How many shares are

outstanding now? What is the new par value per share?
No. of shares:
P30,000/P1 par = 30,000 shares

30,000 x 4/1 = 120,000 shares outstanding

New Par value:

P30,000 / 120,000 shares =
P.25 per share
 PROBLEM NO. 3
Ordinary Shares(P1 par) 30,000
Capital Surplus 285,000
Retained Earnings 649,180
Total Owner’s Equity 964,180

b) Trio declares a 1-for-5 reverse stock split. How many shares are
outstanding now? What is the new par value per share?
No. of shares:
P30,000/P1 par = 30,000 shares

30,000 x 1/5 = 6,000 shares outstanding

New Par value:

P30,000 / 6,000 shares =
P5 per share
 ANSWER
PROBLEMS

14
15
21
22
23
PROBLEM 14
PROBLEM 15
PROBLEM 21
PROBLEM 22
PROBLEM 23