Corporate Finance

Dividends and Share Repurchases: Basics

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 Contents
1. Introduction

2. Dividends: Forms

3. Dividends: Payment Chronology

4. Share Repurchases

5. Concluding Remarks (not mentioned in learning

objectives)

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1. Introduction

Owners/ Equity holders

$$
$

Dividends
Share
Repurchases
$$$

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 2. Dividends: Forms
1. Regular Cash Dividends

2. Extra or Special (Irregular) Shareholders

get money
Dividends

3. Liquidating Dividends
Shareholders
4. Stock Dividends get more
shares
5. Stock Splits
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 Cash to Shareholders
Regular Cash Dividends
Cash distributed to shareholders on a regular
schedule

Most dividend paying companies strive to

maintain or increase their dividends

Increasing dividends indicate that company is

growing and is willing to share profits

Some companies offer dividend reinvestment

plans

Dividend policy and payout ratio (Example 1)

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 Cash to Shareholders
Extra or Special (Irregular)
Dividends
Dividend paid by a company which does
not normally pay dividends or a payment
to shareholders which supplements
regular cash dividends

Liquidating Dividends
Assets sold, liabilities settled and
proceeds distributed to shareholders

Dividends paid which exceed

accumulated retained earnings

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 Stock Dividends and Splits
Stock Dividends
Company distributes additional shares
Typically 2 – 10% of shares outstanding

More shares but each is worth less

Stock Splits
With a 2 for 1 split each share is split into two;
economically similar to a 100% stock dividend Academic research suggests that
market value tends to increase
Other types of splits are also possible (Example because dividends and splits are
taken as a positive signal. If
2) Help companies keep share price in a certain earnings don’t increase market
value returns to earlier level.
range
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 Illustration of the Effect of a Stock Dividend
A company has 1 million shares outstanding. You own 500 shares. What is the
impact of a 10% stock dividend?

Before Dividend After

Dividend
Shares outstanding 1,000,000 1,100,000
EPS 1 0.91
Stock price 10 9.09
P/E 10 10
Total market value 10,000,000 10,000,000
Shares owned 500 550
Ownership value 5000 5000

Note that your proportionate ownership has not changed.

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Impact of Dividends on Capital Structure and
Ratios
Cash dividends: assets and equity decrease  capital structure
changes What is the impact on:
Current ratio
Debt to equity ratio

Stock dividends and splits  capital structure does not change

Simply divide the “pie” into smaller pieces
What is the impact on:
Current ratio
Debt-to-equity ratio

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 3. Dividends: Payment Chronology

Declaratio Ex- Holder-of- Payment

n Date Dividend record Date Date
Date

First day that stock Typically two days after ex-dividend date;
trades without shareholder listed in company records will
dividend be deemed to have ownership of the
shares for purposes of receiving
upcoming dividend

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 4. Share Repurchases
Company buys back its own shares: treasury shares or treasury
stock Not considered for dividends, voting or computing EPS
Buy in the open market: gives flexibility because the company can time the
buyback

Fixed price tender offer: can be accomplished quickly but company

usually has to offer a premium; pro-rata if necessary

Dutch Auction: tender offer with range of acceptable prices; for

example, if shares are trading at $50, a company would offer to buy
back 2 million shares in the 51 – 53 range; can be accomplished
quickly, usually at a price lower than a fixed price tender offer

Repurchase by direct negotiation: usually with large shareholder;

wealth transfer from average shareholder to the large shareholder

Example 5
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 Financial Statement Effects of
Repurchases
Share repurchases decreases assets (cash) and equity (retained
earnings) if share repurchase is financed with cash. What is the impact on:

 Liquidity ratios

 Debt to asset ratios

 Debt to equity ratios

 Earnings per share

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Impact on EPS if Company Repurchases Shares with Own
Funds
Compare earnings yield with after-tax yield on company funds

Example: A company has 1 million shares outstanding and the net income is
$10 million. The share price is $20. Cash not needed for
business operations is $5 million. This money is invested and the return is 4%,
after tax. What is the impact on EPS if $5 million is used to
buy back shares.

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Impact on EPS if Company Repurchases Shares with
Borrowed Funds
Compare earnings yield with after-tax yield on borrowed funds

Example: A company has 1 million shares outstanding and the net income is
$2 million. The share price is $20. The company
borrows $5 million at an after-tax rate of 12% in order to buy back shares.
What is the impact on EPS?

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 Effect of Share Repurchase on BVPS:
Example
Companies X and Y buy back 200,000 shares. What is the impact on BVPS?

Company X: 1 million shares, P Company Y: 1 million shares, P = 20

= 20 Book value of equity = $10 Book value of equity = $30 million
million

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Stock Price > Original BVPS  BVPS down Stock Price < Original BVPS 
BVPS up

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Valuation Equivalence of Cash Dividends and Share
Repurchases
Company X has 1 million shares outstanding with a current market value of
$10 per share. The company recent sold a business unit for $2 million and
wants to give this money to shareholders. Two strategies are being
evaluated:
1. Pay an extra (irregular) dividend
2. Repurchase $2 million worth of shares
What is the impact on shareholder wealth of using each method.

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 Summary
• Types of Dividends

• Payment Chronology

• Share Repurchases

• Financial Statement Effects

 Liquidity Ratios
 Solvency Ratios
 EPS
 BVPS

• Valuation Equivalence of Cash Dividends and Share Repurchases

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Thank you

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