Dividend Policy Payout Dividends or use the money to Buy-Back Shares? MSBC 5060 Chapter 19 Dividend Policy Payout Dividends or use the money to Buy-Back Shares?

Main Results: Without Taxes: The price of a stock decreases by the amount of a cash dividend. If a dividend is not paid and the cash is instead used to repurchase shares held by stock holders the reduction in the amount of shares outstanding results in an increases price equal to the amount that would have been paid as a dividend.

Example: Company has Earnings (NI) = $500,000 Number of Shares = 100,000 EPS = $5.00 Assume PE Ratio = 20x PE includes current earnings, risk of earnings and NPVGO (expected growth) Share Price given EPS = $5.00 x 20 = $100 Company also has $100,000 in Excess Cash Excess Cash per Share = $100,000/100,000 = $1 Total Value Per share if dividend is paid = $100 + $1 = $101 Two Choices to pay Excess Cash to Shareholders: Pay $1.00 per share dividend Repurchase $100,000/$101 = 990 Shares

Repurchase $100,000/$101 = 990 Shares Share Value before Repurchase = $101 EPS = $5.00 PE Ratio = 20x Share Price given Earnings = $5 x 20 = $100 Excess Cash per Share = $100,000/100,000 = $1 Share price = $101 After Repurchase Still have same current and expected earnings ($500,000) Fewer Shares: 100,000 – 990 = 99,010 shares So higher EPS = $500,000/99,010 = $5.05 Same PE Ratio = 20 Paying out Excess Cash does not change NPVGO Share Value = $5.05 x 20 = $101 990 Shareholders have $101 in cash 99,010 Shareholders have share worth $101

Price Drop from Cash Dividend – MSFT On November 15, 2004, MSFT paid a $3.08 dividend

Dividends vs. Repurchases 1984 to 2004 From the old edition of this text

Dividends vs. Repurchases 2004 to 2014 (Figure 19.4 Page 584)

So without Taxes Dividends are the same as Repurchases But there are taxes! And dividends and capital gains (resulting from repurchases) are taxed differently Capital Gains are taxed when realized Dividends are taxed when paid Also, Signaling from changing dividends Corporations buy-back stock when managers think it the stock is cheap and don’t when they think it is dear Dividends vs Repurchases