Intro to financial management
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Intro to Financial Management. Dividend Policy. Review. Homework Income stream risks Business risks Operating risk Break-even analysis Operating leverage Capital structure Leverage Coverage ratio Match maturity of financing with ‘maturity’ of asset. Dividend Policy.

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Intro to Financial Management

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Intro to financial management

Intro to Financial Management

Dividend Policy


Review

Review

  • Homework

  • Income stream risks

  • Business risks

  • Operating risk

    • Break-even analysis

    • Operating leverage

  • Capital structure

    • Leverage

    • Coverage ratio

    • Match maturity of financing with ‘maturity’ of asset


Dividend policy

Dividend Policy

  • Dividend payout ratio

    = dividend per share / earnings per share

  • Tradeoff between

    • Dividends and future growth

    • Dividends and external financing


Dividend policy and stock price

Dividend Policy and Stock Price

  • Three views

  • No effect

  • High dividend will increase the stock price

    Reason – less risk to investor

  • Low dividend will increase the stock price

    Reason – investors can defer taxes


Dividend payment theories

Dividend Payment Theories

  • Residual Dividend Theory

    • Pay dividend only if no more investments to make with the cash

  • Clientele Effect

    • Those who want dividends, will invest in dividend paying stocks

    • Those that don’t, won’t

  • Information Effect

    • Dividend payout changes can signal information from the firm

  • Agency Costs

    • Costs, such as reduced stock price, due to agency conflict

    • Dividends may reduce these costs

  • Expectations Theory

    • Market reacts as reality changes relative to their expectations


Dividends in practice

Dividends in Practice

  • Legal restrictions

    • E.g. must have assets > liabilities

  • Liquidity constraints

    • May not have the cash

  • Earnings predictability

    • Future years may not have as good cash flows

  • Maintaining Ownership Control

    • May retain earnings so do not have to issue new stock


Dividend policies

Dividend Policies

  • Constant dividend payout ratio

    • Percent of earning paid is constant

    • Dollar amount will not be

  • Stable dollar dividend

    • Relatively stable (constant) payout

    • Will change only when management thinks appropriate

  • Small regular dividend plus year-end extra

  • One-time dividend payout


Stock dividend and stock splits

Stock Dividend and Stock Splits

  • Stock dividend

    • Distribution of shares proportionate to current holding

  • Stock split

    • Exchange current shares for new, more shares

  • Same effect, different accounting

  • Why?

    • Optimal trading range, perhaps

    • Signal information, perhaps


Stock repurchases

Stock Repurchases

  • When firm buys back its stock from the market

  • Why?

    • Reduces shares on the market

    • Increases EPS, ROE

    • Increases leverage

    • Reduces costs of small (e.g. fractional) shareholders

    • Result, higher stock price

  • What should a firm do with excess cash?Give dividends or repurchase shares?

    • Want long-term gain or cash now?

    • Theoretically, owners should not care

    • Note that Apple is doing both


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