Rough diamonds may sometimes be mistaken for worthless pebbles

—Thomas Browne

For use in Fin2 2010 only

For use in Fin2 2010 only

For use in Fin2 2010 only

For use in Fin2 2010 only

“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

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…

For use in Fin2 2010 only

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

Plus, you should know

Payout options– Regular dividend– Special dividend– Repurchase

Mechanics/dynamics of dividends– Announcement, ex-date, distribution date

For use in Fin2 2010 only

“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

For use in Fin2 2010 only

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

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

Limitations of WACC—formula accounts for tax shields only

For use in Fin2 2010 only