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Dividends and Share Repurchases: Assignment

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Added on  2021/10/04

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Dividendsand Share
repurchases: Basics

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1.Introduction
A dividend isa prorata distribution to shareholders that
declared by the company’s board of directors and may
may not requireapproval by shareholders.
A repurchase of stock is a distribution in the form of
company buying back its stock from shareholders.
The board of directors determines the company’s payout
policy.
Cash dividends and share repurchases are both method
distributing cash to shareholders.
The effects on financial ratios and on shareholders’ investment
returns are differentbetween these two methods.
These distributions mayprovide information about the company’s
future prospects.
Issuing companies cannot deduct distributions to shareholders for
tax purposes.
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2.Dividends: Forms
Cash Distributions
Regular Cash Dividend
Extra Dividend
LiquidatingDividend
Noncash Distributions
Stock Dividend
Stock Split
Reverse Stock Split
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Regular cash dividends
A regular cash dividend is a cash dividend paid
regular intervals of time
The regularintervals may be anyfrequency, but the
most common are quarterly, semiannually, or annually.
Tendency of companies is to maintain or increase
dividends
Often viewedas signals of management’s assessment
the company’s future (that is, whether the company can
maintain the dividend in the future).
Companies prefer not to cut or reduce the dividend.
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Dividend reinvestment plans
A dividend reinvestment plan (DRP) is a programthat
to reinvest cash dividends automatically into the stock of the
company.
The shares provided in exchange for the cash dividends may
in the open market by the issuer or maybe newly issued shar
Advantages to the issuer:
Encourage owners with smaller holdings to accumulate shares.
Raise” new equity capital without flotation costs.
Advantages to the investor:
Cost averaging of share purchases.
Opportunity (in some cases) to buy shares at a discount from
Disadvantages to the investor:
Recordkeeping
Dividends are taxed when “received,” whether reinvested or not.
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Extra or Special Dividends
An extra dividend (or special dividend)is a dividend
that is either paid by a company that does not
dividends regularly or paid by a company in
addition to a regular dividend.
Example: Whole Foods Marketannounced a $2 special
dividend in December 2012. This was in addition
$0.20 per quarter cash dividend.
Motivation: Pay out in strong years without
investors expecting an increased dividend.
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Liquidating dividends
A liquidating dividend is a distribution of cash to
shareholders when
Going out of business, or
Selling a portion of the business, or
Paying a dividend when retained earnings are not
positive.
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Stock Dividends
A stock dividend is the distribution of additional shares
stock to shareholders on a prorata basis.
Alsoknown as a bonus issue of shares.
Generally stated as a percentage of current shares
outstanding.
A stock dividend does not changea shareholder’s
proportionate ownership, the shareholder does not receive
cash, and there are no tax consequences.
Advantages for the issuer:
1. More shares outstanding and,therefore, potential for more
shareholders.
2. Lowers the stock’s price, which maymake it more attractive
investment.
3. No economic effect.
4. Does not affect financial ratios.
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Stock DividendsinPractice
More prevalent in some countries.
Some companies pay stock dividends on a regula
basis; some pay these occasionally.
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Stock Splits
A stock split is a proportionate increase in thenumb
shares outstanding.
Stated in thefollowing form:
Number of new shares : Number of old shares
So, 2:1 means that for each share held before the split,
shareholderholds twoshares after the split.
Stock splits do not affect thedividend yield or the
dividend payout ratio.
Accounting: Memorandum entry, no change in
accounts.
The announcement is generally viewed as a positiv
signal.
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ReverseStock Splits
A reverse stock split is theproportionate reduction in
thenumber of shares.
A reverse stock split has theopposite effect of the
traditional, or forward, stock split:
It reducesthe numberof shares, with the expectation of
increasing the stock price.
A 1:2 reverse stock split resultsin half thenumber
shares outstanding after thesplit.
The goal may be to increase theshare price to mak
more attractive for institutional investors.
Reverse stock splits aremost common for companies
financial distress.
It is not permittedin some countries.
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3.Dividends: Payment Chronology
| | | |
Declaration
Date
Ex-Dividend
Date
Holder-of-Record
Date
Payment Date
Relationship Based on Trade Cycle

Corporation
Issues Dividend
Declaration
Established by
Markets Based on
the Trade
Settlement Cycle
Established by
Corporation as
Date of Ownership
of Stock
Established by
Corporation as
Date the Dividend
Is Actually Paid
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4.Share Repurchases
A share repurchase is the transaction in which the stoc
issuer buys back its shares from investors.
Alsoknown as a share buyback.
Once repurchased, the shares become treasury shares (or
treasury stock).
Share repurchases are restricted by regulations in some
countries.
Motives for repurchasing shares includethe following:
Signal that the stock is undervalued.
Flexibility of distributing cash without the expectation of cash
dividends.
Tax efficiency when the tax rate on capital gains is less than
cash dividends.
Offset share increases from executive stock options.
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Share Repurchase Methods
Buy in the Open
Market
Use brokers to
buy shares.
Method provides
flexibility for the
company.
Fixed PriceTender
Offer
Specify the
number of
shares and the
share price.
Buy pro rata if
oversubscribed.
Dutch Auction
Tender Offer
Specify the
number of
shares and the
range of prices.
Shareholders
determine the
number of
shares they will
sell back and
specify the price
within the range.
Direct Negotiation
Negotiate with a
specific
shareholder.
Method may be
used to prevent
activist”
shareholder
from getting on
board.
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Share repurchase and
Earnings Per Share
The Diluting Company is planning a $100 million share repurc
Its current stock price is $25 per share, and there are 16 million
shares outstandingprior to the repurchase. Earnings per share
withoutthe repurchase would be $3 per share. What is the
earnings per share under each of these twoscenarios?
Scenario 1: Use idle cashon hand.
Scenario 2: Borrow funds at after-tax rate of 7%.
Scenario 1:
Net income = $3 × $16 million = $48 million
EPSScenario 1 = $48 million÷ (16 million – 4 million) = $4 per share
Scenario 2:
Net income = $3 × 16 million – (0.07 × $100 million) = $41 million
EPSScenario 2 = $41 million÷ (16 million – 4 million) = $3.41 per share
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Share repurchase and
Book value Per Share
When the marketprice per share is greaterthan the book
value per share (BVPS),the book value per share of equity
willdecrease with a share repurchase.
Continuingthe Diluting Company example and adding the
book value per share of $20:
Scenario 1:
Book value = ($20 × 16million) – $100 million = $220 millio
BVPSScenario 1= $220 million÷ (16 million – 4 million) = $18.33 per share
Scenario 2:
Book value = ($20 × 16million) – $100 million – $7million =
BVPSScenario 2= $213 million÷ (16 million – 4 million) = $17.75 per share
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Share repurchase vs. Cash
Dividends
If…
The tax consequences of dividends and capital gains are the
same and
The informationcontent of cash dividends and stock
repurchases is the same,
Then theeffectsof cash dividends and repurchases on
shareholder value will be thesame.
Both cash dividends and stock repurchases:
Reduce assets by the amountof the dividend or repurchase.
Reduce equity by the amountof the dividend or repurchase.
Provide investors with the same cash flow.
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5.Concluding Remarks
Share repurchases have a positive effect on share
prices.
Dividend initiations have a positive effect on share
prices.
Dividend increaseshave a positive effect on share
prices.
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6.Summary
Dividends can take the form of regular or irregular cash
payments, stock dividends, or stock splits.
Regular cash dividends represent a commitment to pay cash
stockholders on a quarterly, semiannual, or annual basis.
The key dates for cash dividends, stock dividends, and stock
are the declaration date, the ex-date, the shareholder-of-record
date, and the payment date.
Share repurchases, or buybacks, most often occur in the
market. Alternatively, tender offers occur at a fixed price
price range througha Dutch auction.
Share repurchases made with excess cash have the pote
increase earnings per share, whereas share repurchases
with borrowed funds can increase, decrease, or not affect
earnings per share, depending on the after-tax borrowing rate
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Summary (continued)
A share repurchase is equivalent to the payment
a cash dividend of equal amount in its effect on
shareholders’ wealth, all other things being equal.
Announcement of a share repurchase is sometimes
accompanied by positive excess returns in the
market when the market price is viewed as
reflectingmanagement’s view that the stock is
undervalued.
Initiation of regular cash dividends can also hav
positive impact on share value.
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