Figure 14.2 The Ex-Day Price Drop Ex date +1+2。。。t Price=$10← t。。。-2-10 $1 is the ex-dividend price drop >Price $9 The stock price will fall by the amount of the dividend on the ex date (Time 0).If the dividend is $1 per share,the price will be equal to $10-1 $9 on the ex date. Before ex date(Time-1) Dividend $0 Price $10 On ex date (Time 0) Dividend =$1 Price $9 5
5 Figure 14.2 The Ex-Day Price Drop
Does Dividend Policy Matter? Dividends matter-the value of the stock is based on the present value of expected future dividends Dividend policy may not matter o Dividend policy is the decision to pay dividends versus retaining funds to reinvest in the firm In theory,if the firm reinvests capital now,it will grow and can pay higher dividends in the future 6
6 Does Dividend Policy Matter? n Dividends matter – the value of the stock is based on the present value of expected future dividends n Dividend policy may not matter q Dividend policy is the decision to pay dividends versus retaining funds to reinvest in the firm q In theory, if the firm reinvests capital now, it will grow and can pay higher dividends in the future
Illustration of Irrelevance ■ Consider a firm that can either pay out dividends of $10,000 per year for each of the next two years, or can pay $9,000 next year,reinvest the other $1,000 into the firm,and then pay $11,120 next year.Investors require a 12%return. Market Value with constant dividend $16,900.51 Market Value with reinvestment $16,900.51 If the company will earn the required return,then it doesn't matter when it pays the dividends
7 Illustration of Irrelevance n Consider a firm that can either pay out dividends of $10,000 per year for each of the next two years, or can pay $9,000 next year, reinvest the other $1,000 into the firm, and then pay $11,120 next year. Investors require a 12% return. q Market Value with constant dividend = $16,900.51 q Market Value with reinvestment = $16,900.51 n If the company will earn the required return, then it doesn’t matter when it pays the dividends
Low Payout Please Why might a low payout be desirable? Individuals in upper income tax brackets might prefer lower dividend payouts,with their immediate tax consequences,in favor of higher capital gains Flotation costs-low payouts can decrease the amount of capital that needs to be raised,thereby lowering flotation costs Dividend restrictions -debt contracts might limit the percentage of income that can be paid out as dividends 8
8 Low Payout Please n Why might a low payout be desirable? n Individuals in upper income tax brackets might prefer lower dividend payouts, with their immediate tax consequences, in favor of higher capital gains n Flotation costs – low payouts can decrease the amount of capital that needs to be raised, thereby lowering flotation costs n Dividend restrictions – debt contracts might limit the percentage of income that can be paid out as dividends