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DIVIDEND POLICY - Coggle Diagram
DIVIDEND POLICY
CHOOSING A POLICY
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Legal requirements
- Co Act requires Liquidity & Solvency tests
- paid out of earnings, not share capital
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Contractual constraints
- loan covenants wanting loan paid off first
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DIVIDEND TYPES
1.Capitalisation
- ALL S/Hs receives free shares
- share value stays =
- % shareholding stays =
2.Share split
- ALL S/Hs receives shares (100 shares -> 200 shares)
- % shareholding stays =
- increases marketability of shares
- signals confidence in continuing superior performance
3.Consolidation
- opposite of share split
- reduces shares & prevents takeovers
- share price increases
4.Share Buy-back
- alternative to cash div
- helps increase EPS
- flexibility - not a continuous pmt commitment
- signals shares are undervalued; if doubtful about sustaining div payout, buy back instead
- manage cap structure & D/E ratio
- taxation - set off against SHARE CAP = not div, only CGT for S/H; set off against EARNINGS = div, DWT; purchase by SUB = STT, no DWT
- Cash Dividends
- Dividend in specie (very rare)
TYPES OF POLICIES
- Constant pay-out ratio - fixed % of earnings paid out
- Stable Rand amt - pay out fixed regardless of earnings; mngmnt only increases if certain it won't be reversed
- Low regular dividend + bonus - mix of 2 and 3
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- set of investment opportunities (choose ones where IRR exceeds Required Return)
CUM DIV vs EX DIV
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Ex-div Date - first day the SELLER is entitled to the div.
- Share & Div will trade separately from here
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when ex-div date occurs, share price will decrease by an amt close to the div value (tax affects difference)
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DECISIONS
3 Main Decisions
- investment
- financing
- dividend
Trade-off of Dividend Decision
- pay out or reinvest for future growth
IRRELEVANCE VS
RELEVANCE
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- Most dividends are reinvested
- invest in bonds for steady CF stream
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M&M theory - Co's value driven by (A) value, not by financing means. Dividend payout doesn't matter
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Signalling effect - pmt = mngmnt optimistic of future potential, share price would increase
M&M assumptions of "no taxes, tx costs and mrkt imperfections" is unrealistic
it affects capital structure, which will need to be filled & it also affects WACC, subsequently Co value too
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