Chapter 14.
Tool Kit for Distributions to Shareholders: Dividends and Repurchases
PROCEDURES FOR CASH DISTRIBUTIONS (Section 14.2)
Declaration date: Thursday, November 11, 2010
Dividend goes with stock: Tuesday, December 07, 2010
Ex-dividend date: Wednesday, December 08, 2010
Thursday, December 09, 2010
Holder-of-record date: Friday, December 10, 2010
Payment date: Friday, January 07, 2011
SETTING THE TARGET DISTRIBUTION LEVEL:
THE RESIDUAL DISTRIBUTION MODEL (Section 14.7)
The optimal distribution ratio for a firm is a function of four factors. (1) Investors' preferences for dividends versus capi
(2) The firm's investment opportunities. (3) Its target capital structure. And (4), the availability and cost of external capi
The last three elements can be combined into the residual distribution model. Within the residual model, firms must det
the optimal capital budget, determine the amount of equity needed to fund the capital budget (based upon the target ca
structure), use reinvested earnings to meet equity requirements whenever possible, and make distributions to sharehol
if more earnings are available than are needed for dividends. The residual model can be expressed as:
Distributions = Net Income - [(Target equity ratio) * (Total capital budget)]
Consider a firm whose net income for the current year is $100 million, their target equity ratio is 60%, and the
expected capital budget is $50 million. What are its distributions to be made to shareholders, according to the
residual model?
Net Income $100
Target equity ratio 60%
Total capital budget $50
Distributions = Net Income - [(Target equity ratio) * (Total capital budget)]
= $100 - 60% * $50
= $70
Distribution = 70.0%
What if the expected capital budget rose to $166.67 million?
Total capital budget $166.67
Distributions = = Net Income - [(Target equity ratio) * (Total capital budget)]
= $100 - 60% * $167
= $0
Distribution = 0.0%
The firm could not have a negative dividend, so a negative distribution must be a stock issue rather than a stock
repurchase. Under the residual policy, if investment opportunities exceed net income, the firm should pay zero
dividends and issue stock (or else increase its debt ratio to fund the investment opportunities).
4/11/2010
s and Repurchases
es for dividends versus capital gains.
ity and cost of external capital.
sidual model, firms must determine
et (based upon the target capital
ke distributions to shareholders only
pressed as:
o is 60%, and the
s, according to the
e rather than a stock
rm should pay zero
es).
SECTION 14.7
SOLUTIONS TO SELF-TEST
Hamilton Corporation has a target equity ratio of 65%. Its capital budget is $2 million. If Hamilton has
net income of $1.6 million and follows a residual distribution model, how much will its distribution be?
Capital budget = $2,000,000
Target equity ratio = 65%
Net income = $1,600,000
Residual distribution = $300,000
SECTION 14.9
SOLUTIONS TO SELF-TEST
A firm's most recent FCF was $2.4 million; the FCF is expected to grow at a constant rate of 5%. The WACC is 14% an
shares outstanding. The firm has $12 million in short-term investments which it plans to liquidate distribute in a stock
has no other financial investments or debt. Verify that the value of operations is $28 million. Immediately prior to the r
intrinsic value of equity and the intrinsic stock price? How many shares will be repurchased? How many shares will r
repurchase? Immediately after the repurchase, what are the intrinsic value of equity and the intrinsic stock price?
FCF = $2,400,000
g= 5%
WACC = 14%
nPrior = 2,000,000
Short-term investments (Extra cash) = $12,000,000
Prior Repurchase After Repurchase
Value of operations $28,000,000.0 $28,000,000.0
+ Value of nonoperating assets 12,000,000.0 0.0
Total intrinsic value of firm $40,000,000.0 $28,000,000.0
− Debt 0.0 0.0
− Preferred stock 0.0 0.0
Intrinsic value of equity $40,000,000.0 $28,000,000.0
÷ Number of shares 2,000,000 1,400,000
Intrinsic stock price $20.00 $20.00
# shares repurchased = 600,000
te of 5%. The WACC is 14% and there are 2 million
o liquidate distribute in a stock repurchase; the firm
llion. Immediately prior to the repurchase, what are the
hased? How many shares will remain after the
d the intrinsic stock price?
SECTION 14.13
SOLUTIONS TO SELF-TEST
Suppose you have 1,000 common shares of Burnside Bakeries. The EPS is $6.00, the DPS is $3.00, and
the stock sells for $90 per share. Burnside announces a 3-for-1 split. Immediately after the split, how
many shares will you have, what will the adjusted EPS and DPS be, and what would you expect the stock
price to be?
Shares 1,000
EPS $6
DPS $3
Stock price $90
Split factor (n-for-1) 3
Shares 3,000
EPS $2.00
DPS $1.00
Price $30.00
DPS is $3.00, and
er the split, how
ou expect the stock
