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Financial
Markets
Week Seven
DIVIDEND POLICY
18/04/09 1
REVIEW
18/04/09 2
HOMEWORK
Reading
– Organisations, stakeholders, financial objectives
– Stock, Capital and Money Markets
– Business Plans, Financing Businesses, New Shares
– Time value of Money
– Inflation & Taxes
– Marketable securities
– Capital Structure
– Required return both debt and equity
– WACC
– Investment Appraisal, non DCF / DCF techniques, taxes
– Sensitivity Analysis, Capital Rationing, risky decision making
18/04/09 4
VALUATION RATIOS
Comparative ratios
Firm & Industry specific
18/04/09 5
PRICE TO EARNINGS (P/E)
Calculated as PricePerShare
PE =
EarningsPerShare
Can be used to infer relative value
18/04/09 6
DIVIDEND POLICY
Companies are run for the benefit of a single group
18/04/09 7
FREE CASH FLOW
Free Cash Flow calculated as
Cash Flow from Operations
Minus
Finance Charges
Other Expenses
Changes in Net Working Capital
Changes in Investments
Taxes
Investments necessary to maintain business
18/04/09 8
FREE CASH FLOW
Represents money left over after all bills are paid
18/04/09 9
FREE CASH FLOW
What to do with free cash flow?
Pay down debt (consider projects vs. financing cost)
Investment
“Core Business” or Diversification
Goal of management is to increase shareholder value
18/04/09 10
FREE CASH FLOW
What if a dividend is paid?
18/04/09 11
DIVIDEND EXPECTATIONS
Dividends represent management confidence
18/04/09 12
DIVIDEND EXPECTATIONS
Low income shareholders - high dividend
18/04/09 13
DIVIDEND POLICY
Every firm has a unique view on dividend payouts
DividendGrowth = r * b
With
r the required (expected?) return on new projects
b the percentage of earnings retained
18/04/09 14
DIVIDEND IRRELEVANCE
Modigliani & Miller 1958/1961
Assumptions
– No transaction costs
– Shares are fairly priced in the market
– All projects undertaken by the firm have same risk / reward profile
– Investment decisions not impacted by dividend policy
18/04/09 15
WHY FIRMS MAY NOT PAY
Every firm is different
18/04/09 16
LEGAL ISSUES
UK
– Dividends paid out of free cash flow
– Sometimes government has limited dividends
– Some firms pay in kind e.g., BA with discount airfare
– In kind far more tax efficient
US
– REITS must pay 95% of free cash flow as a dividend
– FFO or Funds from Operations key for analysis
– Sustainability of dividend trivial for REITS
18/04/09 17
Corporate Finance &
Financial
Markets
18/04/09 18