Unit 8 Flashcards
Cash dividends types
Regular
Special
Extra cash
Liquidating
Factors for high dividends payout
- Desire for current income
- Resolution of uncertainty
Clientele effect
Stocks attract particular groups based on dividend yield and resulting tax effects
Clientele effect
Stocks attract particular groups based on dividend yield and resulting tax effects
Advantage of paying dividends
- Underscore good results and supports the stock price
- Allows investors to raise capital at a lower cost because of a mixture of institutional and individual investors
- Stock price usually increases when dividends are new or increased
- Absorb excess CF and reduce agency costs
Disadvantages of paying dividends
- Taxed to recipients
- Reduce internal sources of financing
- Dividend cuts are hard to make without affecting the stock price
Stock dividend
Payment made by firm to its owner in form of stock
Stock split
Increase in firm’s share outstanding without change in owner’s equity
Reverse split
Stock split which firm’s number of shares outstanding is reduced
Current payout methods
- Constant dividend (% of earnings)
- Stable dividend (increases when earnings increase sustainably for long term)
- Residual dividend policy
Residual dividend policy
- Earnings used to invest in projects with positive NPV
- Remaining earnings declared as dividends
- Where no retained earnings left, no dividends are paid
Pros of Residual dividend policy
- Ensures cash is efficiently distributed towards investments
- Requires FEWER new stocks and LOWER flotation costs
Cons of residual dividend policy
- Results in unstable dividends as the dividends are only paid out when the company has paid all its capital expenditures.
- Not suitable for all investors as they want regular returns and not capital appreciation
- -Amounts not distributed is invested is different growth opportunities, which subsequently increases overall risk exposure of the company as such risk can result in a loss if the expected returns are not realized.
- -Gives constantly changing signals regarding management expectations