1. 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?

2. 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.

3. 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

4. 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

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

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

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

8. 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