Dividend policy

Financial Management 2:

By:

Jonel LunarioChristine Manongsong

Professor:

Mr. Nelson Abesamis, CPA

OBJECTIVES:

1. Describe the effect of a dividend policy2. Recognize the difference between the

dividend dates3.Discuss the types of dividend policies

(advantages/disadvantages)4. Explain the financial and operating

factors that affect the amount of dividends paid

5. Differentiate share capital dividends and share splits

DIVIDENDSa distribution from the net profits of a company to its shareholders

DIVIDEND POLICY

The policy a company uses to decide how much it will pay out to shareholders in dividends. 

EFFECTS:

1. Influences the investor’s attitude

2. Impacts financing program and capital

budgeting

3. Affects cash flow

4. Lowers shareholder’s equity

R - record

DIVIDEND DATES

D - declaration

E - ex-dividend

P - payment

• Cash dividends

• Property dividends

• Liability dividends in the form of bond or scrip

• Stock dividends or bonus issue

Dividends out of earnings

Illustration (cash dividend):

The board of directors of an entity, at their meeting on November 20 2012 declared a dividend of P20/share, payable April 30 2013, to shareholders of record on December 31, 2012. The entity has 20,000 shares issued and outstanding with par value of 100.

Illustration (property dividend):

On November 1, 2012, an entity declared a property dividend of equipment payable on March 1, 2013. The carrying amount of the equipment is P3M and the fair value is P2.5M on November 1, 2012. However, the fair value less cost to distribute the equipment is P2.2M on December 31, 2012, P2M on March 1, 2013.

Illustration (scrip dividend):

Scrip dividends are declared in the amount of P200,000 payable in six months at 12% interest.

Illustration (stock dividend):

Share capital, P100 par, 20,000 share authorized, 10,000 shares issued and outstanding.

Types of dividend policies

Stable dividend-per-share policy

1. Pay a predictable dividend every year.

2. Base optimal capital budget on residual retained earnings (after dividend).

Constant dividend-payout ratio

1. Pay a constant proportion of earnings (if positive).

2. Base optimal capital budget on residual retained earnings.

Compromise Policy

Goals, ranked in order of importanceAvoid cutting back on positive NPV projects to pay a dividendAvoid dividend cutsAvoid the need to sell equityMaintain a target debt/equity ratioMaintain a target dividend payout ratio

Companies want to accept positive NPV projects, while avoiding negative signals

Residual-dividend policy

1 Determine the optimal capital budget.2 Determine the retained earnings that can be used

to finance the capital budget.3 Use retained earnings to supply as much of the

equity investment in the capital budget as necessary.

4 Pay dividends only if there are left-over earnings.

Factors that affect the amount of dividends paid

• Legal requirements• Firm’s liquidity position• Repayment need • Expected rate of return• Stability of earning• Desire of control• Access to the capital market• Shareholder’s individual tax situation

Share capital dividends

Funds raised by issuing shares in return for

cash or other considerations. The amount of

share capital a company has can change over

time because each time a business sells new

shares to the public in exchange for cash, the

amount of share capital will increase. Share

capital can be composed of both common and

preferred shares.

Share splits

The issuance of a substantial amount of

additional shares, thereby reducing the par

value of the share capital on a proportionate

basis

Often prompted by desire to reduce the

market price per share, making it easier for

small investors to buy shares

Share Capital repurchases

A program by which a company buys back its own

shares from the marketplace, reducing the number

of outstanding shares. Share repurchase is usually

an indication that the company's management

thinks the shares are undervalued. The company

can buy shares directly from the market or offer its

shareholder the option to tender their shares

directly to the company at a fixed price.

Problems:

In 2012, Elm Company bought 10,000 shares of oil company at a cost of 200,000. On December 1, 2012 Elm Company declared a property dividend of the oil stock to shareholders of record on February 1,2013 payable on February 15, 2013. The oil stock had the following market value:

December 1, 2012 - 250,000

December 31, 2012 - 260,000

February 15, 2013 - 270,000

What is the net change of the property dividend against retained earnings during 2012?

Problems:

Tin Company had 700,000 ordinary shares authorized and 300,000 share outstanding on January 1, 2012.

Jan 31 Declared 10% stick dividend

June 30 Purchased 100,000 shares

Aug 1 Reissued 50,000 shares

Nov 30 Declared 2 for 1 share split

How many ordinary shares are outstanding?

Problems:

Lunario Company declared and distributed 10% stock dividend with fair value of P1.5M and par value of P1M and 25% stock dividend with fair value of P4M and par value of P3.5M. What agreeable amount should be debited to retained earnings for the stock dividends?

Problems:

On January 1, 2013, the BOD of Chorva Company declared a cash dividend of 800,000 to shareholders of record on January 15, 2013 and payable on February 15, 2013. Selected data on December 31, 2012 are as follows:

Accumulated depletion 500,000

Share capital 9,000,000

Share premium 300,000

Retained earnings (Dec 31, 2012) 600,000

Net income 2012 150,000

What amount should be reported as liquidating dividend?