1. Review Goal: M aximize Value of the Firm Past Topics Investment Decision (spending money) Financing Decision (raising money) Future Topics “Variations on a Theme”

2. Today’s Topics Dividends Define (CB / Investment variation) Div & Value of the Firm Capital Structure Define (financing variation) Cap Str & Value of the Firm

3. Dividends A payment made by a company to the shareholders of the company.

4. Types of Dividends  Cash Div  Regular Cash Div  Special Cash Div  Stock Div  Stock Repurchase (4 methods) 1. Buy shares on the market 2. Tender Offer to Shareholders 3. Dutch Auction 4. Private Negotiation (Green Mail)

5. Dividend Terms Record Date Announcement Date Payment Date Ex-Dividend

6. Dividend Payments Aug 14 Aug 25 Aug26Sept 1Sept 15 Declaration With- Ex-dividend Record Payment date dividend date date date date Share price falls

7. Div & Value (M&M Theory) Example: Assume ABC Co. has no extra cash, but declares a $1,000 dividend. They also require $1,000 for current investment needs. Using M&M Theory, and given the following balance sheet information, show how the value of the firm is not altered when new shares are issued to pay for the dividend. Record Date Cash1,000 Asset Value5,000 Total Value6,000 # of Shares 200 price/share $30

8. Div & Value (M&M Theory) Example: Assume ABC Co. has no extra cash, but declares a $1,000 dividend. They also require $1,000 for current investment needs. Using M&M Theory, and given the following balance sheet information, show how the value of the firm is not altered when new shares are issued to pay for the dividend. Record DatePmt Date Cash1,0000 Asset Value5,0005,000 Total Value6,0005,000 # of Shares 200200 price/share $30 $25

9. Div & Value (M&M Theory) Example: Assume ABC Co. has no extra cash, but declares a $1,000 dividend. They also require $1,000 for current investment needs. Using M&M Theory, and given the following balance sheet information, show how the value of the firm is not altered when new shares are issued to pay for the dividend. Record DatePmt DatePost Pmt Cash1,00001,000 ( 40sh @ $25 ) Asset Value5,0005,0005,000 Total Value6,0005,0006,000 # of Shares 200200240 price/share $30 $25$25

10. Div & Value (M&M Theory) Shareholder Value Record Stock6,000 Cash 0 Total6,000 Stock = 200 sh @ $30 = 6,000

11. Div & Value (M&M Theory) Shareholder Value RecordPmt Stock6,0005,000 Cash 01,000 Total6,0006,000 Stock = 200sh @ $25 = 5,000

12. Div & Value (M&M Theory) Shareholder Value RecordPmt Post Stock6,0005,0006,000 Cash 01,000 0 Total6,0006,0006,000 Stock = 240sh @ $25 = 6,000

13. Dividend Theories Leftists (M&M) - Div does not effect value Rightists - Dividends increase value Middle of the roaders - Leftist theory with some reality thrown in.

14. Dividends Increase Value Market Imperfections and Clientele Effect There are natural clients for high-payout stocks, but it does not follow that any particular firm can benefit by increasing its dividends. The high dividend clientele already have plenty of high dividend stock to choose from. These clients increase the price of the stock through their demand for a dividend paying stock.

15. Dividends Increase Value Dividends as Signals Dividend increases send good news about cash flows and earnings. Dividend cuts send bad news. Because a high dividend payout policy will be costly to firms that do not have the cash flow to support it, dividend increases signal a company’s good fortune and its manager’s confidence in future cash flows.

16. Dividends Decrease Value Tax Consequences Companies can convert dividends into capital gains by shifting their dividend policies. If dividends are taxed more heavily than capital gains, taxpaying investors should welcome such a move and value the firm more favorably. In such a tax environment, the total cash flow retained by the firm and/or held by shareholders will be higher than if dividends are paid.

17. Taxes and Dividend Policy Since capital gains are taxed at a lower rate than dividend income, companies should pay the lowest dividend possible. Dividend policy should adjust to changes in the tax code.

18. Taxes and Dividend Policy In U.S., shareholders are taxed twice (figures in dollars)

19. Taxes and Dividend Policy Under imputed tax systems, such as that in Australia, Shareholders receive a tax credit for the corporate tax the firm pays (figures in Australian dollars)

20. Capital Sturcture Review Ch 17 on your own Overview revisited now

21. Example - Macbeth Spot Removers - All Equity Financed M&M (Debt Policy Doesn’t Matter) Expected outcome

22. Example cont. 50% debt M&M (Debt Policy Doesn’t Matter)

23. Example - Macbeth’s - All Equity Financed - Debt replicated by investors M&M (Debt Policy Doesn’t Matter)

24. MM'S PROPOSITION I If capital markets are doing their job, firms cannot increase value by tinkering with capital structure. V is independent of the debt ratio. AN EVERYDAY ANALOGY It should cost no more to assemble a chicken than to buy one whole. No Magic in Financial Leverage

25. Proposition I and Macbeth Macbeth continued

26. Leverage and Returns

27. M&M Proposition II Macbeth continued

28. M&M Proposition II Macbeth continued

29. r DEDE rDrD rErE M&M Proposition II rArA Risk free debtRisky debt

30. Leverage and Risk Macbeth continued Leverage increases the risk of Macbeth shares

31. Leverage and Returns

32. WACC  WACC is the traditional view of capital structure, risk and return.

33. WACC.10=r D.20=r E.15=r A BEBE BABA BDBD Risk Expected Return Equity All assets Debt

34. WACC Example - A firm has $2 mil of debt and 100,000 of outstanding shares at $30 each. If they can borrow at 8% and the stockholders require 15% return what is the firm’s WACC? D = $2 million E = 100,000 shares X $30 per share = $3 million V = D + E = 2 + 3 = $5 million

35. WACC Example - A firm has $2 mil of debt and 100,000 of outstanding shares at $30 each. If they can borrow at 8% and the stockholders require 15% return what is the firm’s WACC? D = $2 million E = 100,000 shares X $30 per share = $3 million V = D + E = 2 + 3 = $5 million

36. r DVDV rDrD rErE r E =WACC WACC

37. r DVDV rDrD rErE WACC (traditional view)