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Rough diamonds may sometimes be mistaken for worthless pebbles
—Thomas Browne
For use in Fin2 2010 only
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“Do you know the only thing that gives me pleasure? It's to see my dividends coming in.” —John D. Rockefeller
[What a loser quote!—CYB]
For use in Fin2 2010 only
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Three major financial policies
Optimal/Target capital structure– How much debt?
» Stone Container
Payout policy– Dividends and repurchases
» Linear Tech
Risk management/hedging policy– Still to come…
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Payout Policy—Checklist Can the company afford to pay a regular dividend?
– Volatility of cash flow
– Profitability: how fast is cash replenished by profits?
– Low operating leverage makes a regular dividend sustainable
– Perceived big penalties for cutting regular dividends—self-fulfilling prophecy
How much should the company hold in cash?
– Tax disadvantage of holding cash
– Agency cost of “excess cash”
– vs. Strategic Value of cash for » M &A» Price wars» Large capital investments
– Excess cash can be returned to shareholders via special dividend or repurchases
Signalling—ambiguous– High payouts signal times are good, no fear
– High payouts signal no more opportunities© Carliss Y. Baldwin, 2010For use in Fin2 2010 only
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Plus, you should know
Payout options– Regular dividend– Special dividend– Repurchase
Mechanics/dynamics of dividends– Announcement, ex-date, distribution date
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“Capital as such is not evil; it is its wrong use that is evil. Capital in some form or other will always be needed.”
— Mohandas Gandhi
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ßE,comp
RA
RE
ßD
ßA
ßE
RD
WACC = (D/V)Rd(1-t) + (E/V)Re
ßD,comp
Unlever at comp’sactual D/V(Needd)
Relever at target D/V
(Needd)
CAPM
CAPM
CAPM
CAPM: Ri = Rf + i(Risk Premium)Betas: a = (D/V)d + (E/V)e
be = ba + (D/E)(ba – bd)
WACC calculations roadmap
For use in Fin2 2010 only
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ßE,comp
RA
RE
ßD
ßARD
WACC =Ra - t Rd D/V
ßD,comp
Unlever at comp’sactual D/V(Needd)
CAPM
M&M Prop. II
(Need Rd)
CAPM
CAPM: Ri = Rf + i(Risk Premium)M&MII: Ra = (D/V)Rd + (E/V)Re
Portfolio Betas: a = (D/V)d + (E/V)e
An shorter route, arriving at the same place
CAPM
For use in Fin2 2010 only
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Limitations of WACC—formula accounts for tax shields only
For use in Fin2 2010 only