Chapter 11 #3

Question 1

How to calculate earnings per share?

Answer 1

Income available to common shareholders divided by common shares outstanding

Question 2

How does a dividend payment reduce the share price of a corporation

Answer 2

By transferring value from the corporation to the shareholder

Question 3

how do corporations pay dividends

Answer 3

• corporations pay dividends with after tax dollars

Question 4

Do individuals pay taxes on dindends?

Answer 4

Individuals are subject to tax on dividend income

Question 5

Define payout policy

Answer 5

Used to refer to a firms overall policy regarding distributions of value to stockholders

Question 6

Define dividend & pro-rata basis

Answer 6

Something of value that is distributed to a firms stockholders on a pro-rata basis -in proportion to the percentage of the firms shares that they own

Question 7

What does a dividend reduce?

Answer 7

• stockholders claim against the firm
• stockholders investment in a firm by returning some of that investment back to them

Question 8

What are the 4 types of dividends?

Answer 8

1) regular cash dividend
2) extra dividend
3) special dividend
4) liquidating dividend

Question 9

Explain regular cash dividend

Answer 9

• most common form
• cash dividend that is paid on a quarterly basis
• firm returns some of their profits to stockholders
• size of the firms regular cash dividend is typically set at a level that management expects the company to maintain in the long-run

Question 10

Explain extra dividend

Answer 10

• paying extra dividend if earnings are higher than expected
• meet target distribution without updating regular cash payment
• ensures that a minimum portion of earnings is distributed to stockholders

Question 11

Explain special dividend

Answer 11

• one time payment to stockholders
• larger than extra dividends & occurs less frequently
  -Used to distribute unusually large amounts of cash
  -Might also be used to distribute the proceeds from sale of major asset or a means of altering a company’s capital structure

Question 12

Explain liquidating dividend

Answer 12

• The final dividend that is paid to stockholders when a firm is liquidated
• firm being liquidated means its assets are sold
• proceeds from the sale of the assets are distributed and the firm ceases to exist

Question 13

What is a dividend yield? How to calculate?

Answer 13

Financial ration that shows how much a company pays out in dividends each year relative to its Stock price
Calculation: dividend amount (annual) divided by stock price

Question 14

Who authorizes a dividend payment?

Answer 14

Board of directors

Question 15

Explain the dividend payment process

Answer 15

Board vote: vote by the BOD to pay a dividend. Board must approve any distribution of value to stockholders

Public announcement: date which announcement is made is known as the declaration date of dividend. Announcement includes amount of value, other dates associated with dividend

The ex-dividend date: first date which the stocks will trade without rights to the dividend. Investor who buys the stock on or after this date will not receive the dividend

Record date: date one must be a stockholder of record to receive a dividend. Set by the board. 2 business days after the ex-dividend date this reflects the time needed to compile and update the records of stock ownership

Payable date: date the dividend will actually be paid

Question 16

Dividend payment process at private companies

Answer 16

-shares bought & sold less frequently
- fewer stockholders
- no stock exchanged involved in the dividend payment process
- No public announcement or ex-dividend date
- record date & payable date any day on or after the day the board approves the dividend

Question 17

What is a Stock repurchase?

Answer 17

With a stock repurchase, a company buys some of its shares from stockholders

Question 18

How stock repurchases differ from dividends

Answer 18

• Do not represent a pro-rata distribution of value
• when a company repurchases its own shares, it removes them from circulation
• Taxed differently - total value of dividends usually taxed but with repurchases, only the profit made is taxed. Treated as capital gain. Only 50% of profit is taxed
• accounted for differently. Both dividends & shave repurchase decrease cash asset but dividends decrease retained earnings on liabilities and SE side while share repurchases decrease liabilities und SE side by increasing treasury stocks

Question 19

What are the 3 ways stocks are repurchased?

Answer 19

• Open market repurchases
• Tender offer
• Targeted Stock Repurchases

Question 20

Explain open market repurchases

Answer 20

• firm purchases shares at the exchange in the same manner as normal trades
• convenient for small ongoing repurchases
• regulations in place to prevent price manipulation by limiting the amount that a company can purchase at the exchange in a day
• these regulations make it hard for large share repurchases

Question 21

Explain tender offer repurchases

Answer 21

Fixed price offer
- company offers a fixed price to investors and max shares they will repurchase.
- interested stockholders tender their shares by letting management know # shares they’ll sell
- if #or shares tendered > announced max. Then each stockholder who tendered shares participates in the repurchase in portion to the fraction or total shares tendered
Dutch auction offer
- company asks the stockholders the # of shares they would sell at a series of prices
- stockholders tell the company how many shares they would sell at each price

Question 22

Explain targeted Stock repurchase

Answer 22

• involves direct negotiation with specific stokeholder
  -Typically used to buy blocks of shares from large stokeholders

Question 23

The general conditions under which Capital structure policy does not affect firm values

Answer 23

• there are no taxes
• there are no information or transaction costs
• the real investment policy of the firm is fixed
  Dividend policy does not matter under the able conditions because stockholder can “manufacture” any dividends they want at no cost

Question 24

Benefits of dividends

Answer 24

-Attract investors who prefer to receive income directly from their investments. However the tax costs might drive other investors away
- function as a signal to investors that the company is performing well & has higher then expected cash flows
- can help align manager & stockholder incentives
- reduce equity claims on the company; this can help managers achieve the target capital structure suggested by the trade-off theory

Question 25

Cost of dividends

Answer 25

- taxes: dividends have historically taxed at a higher price than other forms of income - reinvestment costs: investors who don't intend to spend the cash must pay the transaction costs associated with reinvesting - increased cost of debt: fewer valuable assets = debts holders at greater risk of default and will be charged the company a higher rate on its debt to compensate the greater risk

Question 26

What is cash flow identity

Answer 26

During any period, the sources up cash must equal the uses of cash in a firm The cash flow identity suggests that managers change dividends when something fundamental has changed in the business causing the stock price to change

Question 27

Dividends vs stock repurchases

Answer 27

- give stockholders ability to choose when they recite the distribution, - Stockholders who sell shares back to a company pay taxes only on the gains they realize, and historically these capital gains have been taxed at a lower rate than dividends - Stock repurchases provide companies greater flexibility in distributing value

Question 28

What are Stock dividends

Answer 28

- Do not involve the distribution of value - shareholders receive shares ( usually %) - company pays a stock dividend, it distributes new shares of stock on a pro-rata basis to existing stockholders - number of shares each stockholder owns increases and their value goes down ( left with same value as before)

Question 29

What is a Stock split?

Answer 29

actual division of each share into more than one share

Question 30

key distinction between stock dividends and stock splits

Answer 30

stock dividends are typically regularly scheduled events, like regular cash dividends, while stock splits tend to occur infrequently during the life of a company

Question 31

What is the trading range argument

Answer 31

- proposes that successful companies use stack dividends or stack splits to make their shares more attractive to investors - more expensive for investors to purchase odd lots of less than 100 shares than round lots of 100 shares - odd lots less liquid then round because investors want to but round - expensive the companies to service odd lot - When buying an odd lot becomes too expensive, investors might avoid buying the stock at all cost and stocks dividends and splits offer way to bring the price of the stock down to the appropriate trading range - stock splits send positive signals to investors - reverse stock splits can happen as well

Question 32

What did the 2005 study conclude about how managers view stock repurchases?

Answer 32

- managers view repurchases as the preferred option for returning extra cash - managers prefer the flexibility of share repurchase plans, - managers believe that the decision between share repurchases and dividend payments has little effect on what type of investor is likely to own the company’s stock.

Question 33

Practical considerations in setting a dividend payout

Answer 33

- The level of earnings in excess of a company’s investment requirements over the long run and how certain this level is. - Whether the firm has sufficient financial reserves to maintain the dividend payout during periods when earnings are down or investment opportunities are up. - Whether the firm has sufficient financial flexibility to maintain dividends if unforeseen circumstances wipe out its financial reserves when earnings are down. - Whether the firm is able to quickly raise enough capital if necessary. - The control (voting) implications if a firm chooses to finance dividends by selling equity