Aswath D

amodaran

127

Returning C

ash to the Ow

ners:D

ividend Policy

Asw

ath Dam

odaran

Aswath D

amodaran

128

First P

rinciples

QInvest in projects that yield a return greater than the m

inimum

acceptable hurdle rate.

The hurdle rate should be higher for riskier projects and reflect the

financing mix used - ow

ners funds (equity) or borrowed m

oney (debt)

R

eturns on projects should be measured based on cash flow

s generatedand the tim

ing of these cash flows; they should also consider both positive

and negative side effects of these projects.

QC

hoose a financing mix that m

inimizes the hurdle rate and m

atches theassets being financed.

QIf there are not enough investm

ents that earn the hurdle rate,return the cash to stockholders.

The form

of returns - dividends and stock buybacks - will depend

upon the stockholders characteristics.

Objective: M

aximize the V

alue of the Firm

Aswath D

amodaran

129

Dividends are sticky

Dividend C

hanges : 1989-1998

0.00%

10.00%

20.00%

30.00%

40.00%

50.00%

60.00%

19891990

19911992

19931994

19951996

19971998

Year

% of all firms

Increasing dividendsD

ecreasing dividendsN

ot changing dividends

Aswath D

amodaran

130

Dividends tend to follow

earnings

Figure 21.5: Dividends and Earnings at US Firms: 1960 - 1998

0.0

0

5.0

0

10

.00

15

.00

20

.00

25

.00

30

.00

35

.00

40

.00

45

.00

1960

1961

1962

1963

1964

1965

1966

1967

1968

1969

1970

1971

1972

1973

1974

1975

1976

1977

1978

1979

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

Year

$ Dividends/Earnings

Earnings

Dividends

Aswath D

amodaran

131

More and m

ore firms are buying back stock,

rather than pay dividends...

Fig

ure

2

2.1

: S

toc

k

Bu

yb

ac

ks

a

nd

D

ivid

en

ds

: A

gg

reg

ate

fo

r U

S

Firm

s

- 1

98

9-9

8

$-

$5

0,0

00

.00

$1

00

,00

0.0

0

$1

50

,00

0.0

0

$2

00

,00

0.0

0

$2

50

,00

0.0

0

19

88

19

89

19

90

19

91

19

92

19

93

19

94

19

95

19

96

19

97

19

98

Ye

ar

Stock B

uybacksD

ivide

nd

s

Aswath D

amodaran

132

Measures of D

ividend Policy

QD

ividend Payout:

measures the percentage of earnings that the com

pany pays in dividends

=

Dividends / E

arnings

QD

ividend Yield

:

measures the return that an investor can m

ake from dividends alone

=

Dividends / Stock Price

Aswath D

amodaran

133

Dividend P

ayout Ratios: January 2002

0

20

40

60

80

100

120

140

160

180

0-5%

5-10%

10-15%

15-20%

20-25%

25-30%

30-35%

35-40%

40-45%

45-50%

50-60%

60-70%

70-80%

80-90%

90-100%

>100%

Div

iden

d P

ayo

ut R

atio

s: Jan

uary

20

02

Firm

s paying/not paying dividends

0

500

1000

1500

2000

2500

Pay divid

ends

Pay no d

ividen

ds

Number of firms

Aswath D

amodaran

134

Dividend Y

ields in the United S

tates: January2002

0

50

100

150

200

2500-0.25%

0.25-0.5%0.5-0.75%

0.75-%

1-1.25%

1-1.5%1.5-1.75%

1.75-2%

2-2.5%

2.5-3%

3-3.5%

3.5-4%

4-5%

>5%

Div

iden

d Y

ield

s: Jan

uary

20

02

Num

ber o

f divid

end Payin

g firm

s = 1

800

Num

ber o

f non-d

ividen

d Payin

g firm

s = 3

971

Aswath D

amodaran

135

Three S

chools Of T

hought On D

ividends

Q1. If

(a) there are no tax disadvantages associated with dividends

(b) com

panies can issue stock, at no cost, to raise equity, whenever

needed

D

ividends do not matter, and dividend policy does not affect value.

Q2. If dividends have a tax disadvantage,

D

ividends are bad, and increasing dividends will reduce value

Q3. If stockholders like dividends, or dividends operate as a signal of future prospects,

D

ividends are good, and increasing dividends will increase value

Aswath D

amodaran

136

The balanced view

point

QIf a com

pany has excess cash, and few good projects (N

PV>

0),returning m

oney to stockholders (dividends or stock repurchases) isG

OO

D.

QIf a com

pany does not have excess cash, and/or has several goodprojects (N

PV>

0), returning money to stockholders (dividends or

stock repurchases) is BA

D.

Aswath D

amodaran

137

Why do firm

s pay dividends?

QT

he Miller-M

odigliani Hypothesis: D

ividends do not affect valueQ

Basis:

If a firm's investm

ent policy (and hence cash flows) don't change, the

value of the firm cannot change w

ith dividend policy. If we ignore

personal taxes, investors have to be indifferent to receiving eitherdividends or capital gains.

QU

nderlying Assum

ptions:

(a) There are no tax differences betw

een dividends and capital gains.

(b) If com

panies pay too much in cash, they can issue new

stock, with no

flotation costs or signaling consequences, to replace this cash.

(c) If com

panies pay too little in dividends, they do not use the excesscash for bad projects or acquisitions.

Aswath D

amodaran

138

The T

ax Response: D

ividends are taxed more

than capital gains

QB

asis:

Dividends are taxed m

ore heavily than capital gains. A stockholder w

illtherefore prefer to receive capital gains over dividends.

QE

vidence:

Exam

ining ex-dividend dates should provide us with som

e evidence onw

hether dividends are perfect substitutes for capital gains.

Aswath D

amodaran

139

Price B

ehavior on Ex-D

ividend Date

Let P

b = Price before the stock goes ex-dividend

Pa =

Price after the stock goes ex-dividend D

= D

ividends declared on stock to , tcg =

Taxes paid on ordinary incom

e and capital gains respectively

$ Pb$Pa

______________|_______ Ex-Dividend Day _______________|

Aswath D

amodaran

140

Cashflow

s from S

elling around Ex-D

ividendD

ay

QT

he cash flows from

selling before then are-P

b - (Pb - P) tcg

QT

he cash flows from

selling after the ex-dividend day are-P

a - (Pa - P) tcg +

D(1-to )

Since the average investor should be indifferent between selling before

the ex-dividend day and selling after the ex-dividend day -P

b - (Pb - P) tcg =

Pa - (P

a - P) tcg + D

(1-to )M

oving the variables around, we arrive at the follow

ing:

Aswath D

amodaran

141

Price C

hange, Dividends and T

ax Rates

IfP

b - Pa =

Dthen

to = tcg

Pb - P

a < D

then to >

tcgP

b - Pa >

Dthen

to < tcg

Pb

Pa

D =

(1

-to )

(1 t

cg )

Aswath D

amodaran

142

The E

vidence on Ex-D

ividend Day B

ehavior

OrdinaryInco

meCapital

Gains(

Pb-

Pa )/D

Before1981

70%

28%

0.78(1966-69)

1981-8550

%20

%0.85

1986-199028

%28

%0.90

1991-199333

%28

%0.92

1994..39.6

%28

%0.90

Aswath D

amodaran

143

Dividend A

rbitrage

QA

ssume that you are a tax exem

pt investor, and that you know that the

price drop on the ex-dividend day is only 90% of the dividend. H

oww

ould you exploit this differential?

RInvest in the stock for the long term

RSell short the day before the ex-dividend day, buy on the ex-dividendday

RB

uy just before the ex-dividend day, and sell after.

R______________________________________________

Aswath D

amodaran

144

Exam

ple of dividend capture strategy with tax

factors

QX

YZ

company is selling for $50 at close of trading M

ay 3. On M

ay 4,X

YZ

goes ex-dividend; the dividend amount is $1. T

he price drop(from

past examination of the data) is only 90%

of the dividendam

ount.

QT

he transactions needed by a tax-exempt U

.S. pension fund for thearbitrage are as follow

s:

1. Buy 1 m

illion shares of XY

Z stock cum

-dividend at $50/share.

2. W

ait till stock goes ex-dividend; Sell stock for $49.10/share (50 - 1*0.90)

3. C

ollect dividend on stock.

QN

et profit = - 50 m

illion + 49.10 m

illion + 1 m

illion = $0.10 m

illion

Aswath D

amodaran

145

The w

rong reasons for paying dividendsT

he bird in the hand fallacy

QA

rgument: D

ividends now are m

ore certain than capital gains later.H

ence dividends are more valuable than capital gains.

QC

ounter: The appropriate com

parison should be between dividends

today and price appreciation today. (The stock price drops on the ex-

dividend day.)

Aswath D

amodaran

146

The excess cash hypothesis

QA

rgument: T

he firm has excess cash on its hands this year, no

investment projects this year and w

ants to give the money back to

stockholders.

QC

ounter: So why not just repurchase stock? If this is a one-tim

ephenom

enon, the firm has to consider future financing needs.

Consider the cost of issuing new

stock:

Aswath D

amodaran

147

The C

ost of Raising F

unds

QIssuing new

equity is much m

ore expensive than raising new debt for

companies that are already publicly traded, in term

s of transactionscosts and investm

ent banking fees

QR

aising small am

ounts is much m

ore expensive than raising largeam

ounts, for both equity and debt. Making a sm

all equity issue ( say $25-$ 50 m

illion might be prohibitively expensive)

Aswath D

amodaran

148

Are firm

s perverse? Som

e evidence that theyare not

Aswath D

amodaran

149

Evidence from

Canadian F

irms

Com

panyP

remium

for Cash dividend over

Stock Dividend Shares

Consolidated Bathurst19.30%

Donfasco13.30%

Dome Petroleum

0.30%

Imperial Oil

12.10%

New

foundland Light & Pow

er1.80%

Royal Trustco17.30%

Stelco2.70%

TransAlta1.10%

Average

7.54%

Aswath D

amodaran

150

A clientele based explanation

QB

asis: Investors may form

clienteles based upon their tax brackets.Investors in high tax brackets m

ay invest in stocks which do not pay

dividends and those in low tax brackets m

ay invest in dividend payingstocks.

QE

vidence: A study of 914 investors' portfolios w

as carried out to see iftheir portfolio positions w

ere affected by their tax brackets. The study

found that

(a) Older investors w

ere more likely to hold high dividend stocks and

(b) Poorer investors tended to hold high dividend stocks

Aswath D

amodaran

151

Results from

Regression: C

lientele Effect

Dividend Y

ieldt = a + b t + c Aget + d Incom

et + e Differential Tax R

atet + tV

ariableC

oefficientIm

plies

Constant

4.22%

Beta C

oefficient-2.145

Higher beta stocks pay low

er dividends.

Age/100

3.131Firm

s with older investors pay higher

dividends.

Income/1000

-3.726Firm

s with w

ealthier investors pay lower

dividends.

Differential Tax R

ate-2.849

If ordinary income is taxed at a higher rate

than capital gains, the firm pays less

dividends.

Aswath D

amodaran

152

Dividend P

olicy and Clientele

QA

ssume that you run a phone com

pany, and that you have historicallypaid large dividends. Y

ou are now planning to enter the

telecomm

unications and media m

arkets. Which of the follow

ing pathsare you m

ost likely to follow?

RC

ourageously announce to your stockholders that you plan to cutdividends and invest in the new

markets.

RC

ontinue to pay the dividends that you used to, and defer investment

in the new m

arkets.

RC

ontinue to pay the dividends that you used to, make the investm

entsin the new

markets, and issue new

stock to cover the shortfall

RO

ther

Aswath D

amodaran

153

The S

ignaling Hypothesis

Aswath D

amodaran

154

An A

lternative Story..D

ividends as Negative

Signals

Aswath D

amodaran

155

The W

ealth Transfer H

ypothesis

-2

-1.5 -1

-0.5 0

0.5

t:-1

5-1

2-9

-6-3

03

69

12

15

CA

R (D

iv Up)

CA

R (D

iv down)

EX

CE

SS

RE

TUR

NS

ON

STR

AIG

HT B

ON

DS

AR

OU

ND

DIV

IDE

ND

CH

AN

GE

S

Day (0: A

nnouncement date)

CAR

Aswath D

amodaran

156

Managem

ent Beliefs about D

ividend Policy

QA

firms dividend payout ratio affects its stock price.

QD

ividend payments operate as a signal to financial m

arkets

QD

ividend announcements provide inform

ation to financial markets.

QInvestors think that dividends are safer than retained earnings

QInvestors are not indifferent betw

een dividends and price appreciation.

QStockholders are attracted to firm

s that have dividend policies that theylike.

Aswath D

amodaran

157

Determ

inants of Dividend P

olicy

QInvestm

ent Opportunities: M

ore investment opportunities - >

Low

erD

ividends

QStability in earnings: M

ore stable earnings -> H

igher Dividends

QA

lternative sources of capital: More alternative sources ->

Higher

Dividends

QC

onstraints: More constraints im

posed by bondholders and lenders ->L

ower D

ividends

QSignaling Incentives: M

ore options to supply information to financial

markets - L

ower need to pay dividends as signal

QStockholder characteristics: O

lder, poorer stockholders -> H

igherdividends

Aswath D

amodaran

158

Questions to A

sk in Dividend P

olicy Analysis

QH

ow m

uch could the company have paid out during the period under

question?

QH

ow m

uch did the the company actually pay out during the period in

question?

QH

ow m

uch do I trust the managem

ent of this company w

ith excesscash?

How

well did they m

ake investments during the period in question?

H

ow w

ell has my stock perform

ed during the period in question?

Aswath D

amodaran

159

A M

easure of How

Much a C

ompany C

ouldhave A

fforded to Pay out: F

CF

E

QT

he Free Cashflow

to Equity (FC

FE) is a m

easure of how m

uch cashis left in the business after non-equity claim

holders (debt and preferredstock) have been paid, and after any reinvestm

ent needed to sustain thefirm

s assets and future growth.

Net Incom

e

+ D

epreciation & A

mortization

= C

ash flows from

Operations to E

quity Investors

- Preferred Dividends

- Capital E

xpenditures

- Working C

apital Needs

- Principal Repaym

ents

+ Proceeds from

New

Debt Issues

= Free C

ash flow to E

quity

Aswath D

amodaran

160

Estim

ating FC

FE

when Leverage is S

table

Net Incom

e

- (1- ) (Capital E

xpenditures - Depreciation)

- (1- ) Working C

apital Needs

= Free C

ash flow to E

quity

= D

ebt/Capital R

atio

For this firm,

Proceeds from

new debt issues =

Principal Repaym

ents + (C

apitalE

xpenditures - Depreciation +

Working C

apital Needs)

Aswath D

amodaran

161

An E

xample: F

CF

E C

alculation

QC

onsider the following inputs for M

icrosoft in 1996. In 1996,M

icrosofts FCFE

was:

N

et Income =

$2,176 Million

C

apital Expenditures =

$494 Million

D

epreciation = $ 480 M

illion

C

hange in Non-C

ash Working C

apital = $ 35 M

illion

D

ebt Ratio =

0%

QFC

FE =

Net Incom

e - (Cap ex - D

epr) (1-DR

) - Chg W

C (!-D

R)

=$ 2,176

- (494 - 480) (1-0)- $ 35 (1-0)

=

$ 2,127 Million

Aswath D

amodaran

162

Microsoft: D

ividends?

QB

y this estimation, M

icrosoft could have paid $ 2,127 Million in

dividends/stock buybacks in 1996. They paid no dividends and bought

back no stock. Where w

ill the $2,127 million show

up in Microsofts

balance sheet?

Aswath D

amodaran

163

Dividends versus F

CF

E: U

.S.

Fig

ure

1

1.1

: D

ivid

en

ds

/FC

FE

:

NY

SE

F

irms

in

1

99

6

0

20

0

40

0

60

0

80

0

10

00

12

00

14

00

16

00

18

00

0 %

0 -10%

10 -20%

20- 30%

30 - 40%

4 0 - 5 0 %

50 - 60%

60 -70%

70 - 80%

80 -90%

90 - 100%

> 100%

Div

ide

nd

s/F

CF

E

Number of Firms

Aswath D

amodaran

164

The C

onsequences of Failing to pay F

CF

E

Ch

rys

ler: F

CF

E, D

ivid

en

ds

an

d C

as

h B

ala

nc

e

($5

00

)

$0

$5

00

$1

,00

0

$1

,50

0

$2

,00

0

$2

,50

0

$3

,00

0

19

85

19

86

19

87

19

88

19

89

19

90

19

91

19

92

19

93

19

94

Ye

ar

Cash Flow

$0

$1

,00

0

$2

,00

0

$3

,00

0

$4

,00

0

$5

,00

0

$6

,00

0

$7

,00

0

$8

,00

0

$9

,00

0

Cash Balance

= F

ree

CF

to E

qu

ity =

Ca

sh to

Sto

ckho

lde

rsC

umulated C

ash

Aswath D

amodaran

165

A

pplication Test: E

stimating your firm

sF

CF

E

In General,

If cash flow statem

ent usedN

et Income

Net Incom

e+

Depreciation &

Am

ortization+

Depreciation &

Am

ortization- C

apital Expenditures

+ C

apital Expenditures

- Change in N

on-Cash W

orking Capital

+ C

hanges in Non-cash W

C- Preferred D

ividend+

Preferred Dividend

- Principal Repaid

+ Increase in L

T B

orrowing

+ N

ew D

ebt Issued+

Decrease in L

T B

orrowing

+ C

hange in ST B

orrowing

= FCFE

= FCFE

Com

pare toD

ividends (Com

mon)

-Com

mon D

ividend+

Stock Buybacks

- Decrease in

C

apital Stock+ Increase in

Capital Stock

Aswath D

amodaran

166

A P

ractical Fram

ework for A

nalyzing Dividend

Policy

How

much did the firm

pay out? How

much could it have afforded to pay out?

What it could have paid out

What it actually paid out

Net Incom

eD

ividends- (C

ap Ex - D

eprn) (1-DR

)+

Equity R

epurchase- C

hg Working C

apital (1-DR

)= F

CF

E

Firm

pays out too littleF

CF

E > D

ividendsF

irm pays out too m

uchF

CF

E < D

ividends

Do you trust managers in the com

pany withyour cash?Look at past project choice:C

ompare

RO

E to C

ost of Equity

RO

C to W

AC

C

What investm

ent opportunities does the firm

have?Look at past project choice:C

ompare

RO

E to C

ost of Equity

RO

C to W

AC

C

Firm

has history of good project choice and good projects in the future

Firm

has historyof poor project choice

Firm

has good projects

Firm

has poor projects

Give m

anagers the flexibility to keep cash and set dividends

Force m

anagers to justify holding cash or return cash to stockholders

Firm

should cut dividends and reinvest m

ore

Firm

should deal w

ith its investment

problem first and

then cut dividends

Aswath D

amodaran

167

A D

ividend Matrix

FC

FE

- Divid

end

s

Good P

rojectsP

oor Projects

Maxim

umFlexibility in D

ividend Policy

Reduce cash

payout to stockholders

Significant pressureo

n m

an

agers to pay cash out

Investment and

Dividend

problems; cut

dividends but also check project choice

Aswath D

amodaran

168

Disney: A

n analysis of FC

FE

from 1992-1996

Year

Net Incom

e(C

ap Ex- D

epr) C

hg in WC

FC

FE

(1- Debt R

atio)(1-D

ebt Ratio)

1992$817

$173 ($81)

$725

1993$889

$328 $160

$402

1994$1,110

$469 $498

$143

1995$1,380

$325 $206

$849

1996*$1,214

$466 ($470)

$1,218

Avge

$1,082 $352

$63$667

(The num

bers for 1996 are reported without the C

apital Cities

Acquisition)

The debt ratio used to estim

ate the free cash flow to equity w

as estimated

as follows =

Net D

ebt Issues/(Net C

ap Ex +

Change in N

on-cash WC

)

Aswath D

amodaran

169

Disneys D

ividends and Buybacks from

1992 to1996

Year

FCFE

Dividends +

Stock Buybacks

1992$725

$105

1993$402

$160

1994$143

$724

1995$849

$529

1996$1,218

$733

Average

$667 $450

Aswath D

amodaran

170

Disney: D

ividends versus FC

FE

QD

isney paid out $ 217 million less in dividends (and stock buybacks)

than it could afford to pay out. How

much cash do you think D

isneyaccum

ulated during the period?

Aswath D

amodaran

171

Can you trust D

isneys managem

ent?

QD

uring the period 1992-1996, Disney had

an average return on equity of 21.07%

on projects taken

earned an average return on 21.43%

for its stockholders

a cost of equity of 19.09%

QD

isney has taken good projects and earned above-market returns for its

stockholders during the period.

QIf you w

ere a Disney stockholder, w

ould you be comfortable w

ithD

isneys dividend policy?

RY

es

RN

o

Aswath D

amodaran

172

Disney: R

eturn Perform

ance Trends

Re

turn

s o

n E

qu

ity, S

toc

k a

nd

Re

qu

ired

Re

turn

s - D

isn

ey

-10

.00

%

0.0

0%

10

.00

%

20

.00

%

30

.00

%

40

.00

%

50

.00

%

60

.00

%

19

92

19

93

19

94

19

95

19

96

Ye

ar

RO

ER

etu

rns o

n S

tock

Re

qu

ired

Re

turn

Aswath D

amodaran

173

The B

ottom Line on D

isney Dividends

QD

isney could have afforded to pay more in dividends during the period

of the analysis.

QIt chose not to, and used the cash for the A

BC

acquisition.

QT

he excess returns that Disney earned on its projects and its stock over

the period provide it with som

e dividend flexibility. The trend in these

returns, however, suggests that this flexibility w

ill be rapidly depleted.

QT

he flexibility will clearly not survive if the A

BC

acquisition does notw

ork out.

Aswath D

amodaran

174

Aracruz: D

ividends and FC

FE

: 1994-1996

19941995

1996N

et Income

BR

248.21 B

R326.42

BR

47.00 - (C

ap. Exp - D

epr)*(1-DR

)B

R174.76

BR

197.20 B

R14.96

- Working C

apital*(1-DR

)(B

R47.74)

BR

15.67 (B

R23.80)

= Free C

F to Equity

BR

121.19 B

R113.55

BR

55.84

Dividends

BR

80.40 B

R113.00

BR

27.00 +

Equity R

epurchasesB

R 0.00

BR

0.00B

R 0.00

= C

ash to StockholdersB

R80.40

BR

113.00 B

R27.00

Aswath D

amodaran

175

Aracruz: Investm

ent Record

19941995

1996P

roject Perform

ance Measures

RO

E19.98%

16.78%2.06%

Required rate of return

3.32%28.03%

17.78% D

ifference16.66%

-11.25%-15.72%

Stock Perform

ance Measure

Returns on stock

50.82%-0.28%

8.65%R

equired rate of return3.32%

28.03%17.78%

Difference

47.50%-28.31%

-9.13%

Aswath D

amodaran

176

Aracruz: Its your call..

QA

ssume that you are a large stockholder in A

racruz. They have a

history of paying less in dividends than they have available in FCFE

and have accumulated a cash balance of roughly 1 billion B

R (25%

ofthe value of the firm

). Would you trust the m

anagers at Aracruz w

ithyour cash?

RY

es

RN

o

Aswath D

amodaran

177

Mandated D

ividend Payouts

QT

here are many countries w

here companies are m

andated to pay out acertain portion of their earnings as dividends. G

iven our discussion ofFC

FE, w

hat types of companies w

ill be hurt the most by these law

s?

RL

arge companies m

aking huge profits

RSm

all companies losing m

oney

RH

igh growth com

panies that are losing money

RH

igh growth com

panies that are making m

oney

Aswath D

amodaran

178

BP

: Dividends- 1983-92

12

34

56

78

910

Net Incom

e$1,256.00

$1,626.00$2,309.00

$1,098.00$2,076.00

$2,140.00$2,542.00

$2,946.00$712.00

$947.00

- (Cap. E

xp - Depr)*(1-D

R)

$1,499.00$1,281.00

$1,737.50$1,600.00

$580.00$1,184.00

$1,090.50$1,975.50

$1,545.50$1,100.00

Working C

apital*(1-DR

)$369.50

($286.50)$678.50

$82.00($2,268.00)

($984.50)$429.50

$1,047.50($305.00)

($415.00)

= Free C

F to Equity

($612.50)$631.50

($107.00)($584.00)

$3,764.00$1,940.50

$1,022.00($77.00)

($528.50)$262.00

Dividends

$831.00$949.00

$1,079.00$1,314.00

$1,391.00$1,961.00

$1,746.00$1,895.00

$2,112.00$1,685.00

+ E

quity Repurchases

= C

ash to Stockholders$831.00

$949.00$1,079.00

$1,314.00$1,391.00

$1,961.00$1,746.00

$1,895.00$2,112.00

$1,685.00

Dividend R

atios

Payout Ratio

66.16%58.36%

46.73%119.67%

67.00%91.64%

68.69%64.32%

296.63%177.93%

Cash Paid as %

of FCFE

-135.67%150.28%

-1008.41%-225.00%

36.96%101.06%

170.84%-2461.04%

-399.62%643.13%

Perform

ance Ratios

1. Accounting M

easure

RO

E9.58%

12.14%19.82%

9.25%12.43%

15.60%21.47%

19.93%4.27%

7.66%

Required rate of return

19.77%6.99%

27.27%16.01%

5.28%14.72%

26.87%-0.97%

25.86%7.12%

Difference

-10.18%5.16%

-7.45%-6.76%

7.15%0.88%

-5.39%20.90%

-21.59%0.54%

Aswath D

amodaran

179

BP

: Sum

mary of D

ividend Policy

Summ

ary of calculations

Average

Standard Deviation

Maxim

umM

inimum

Free C

F to E

quity$571.10

$1,382.29$3,764.00

($612.50)

Dividends

$1,496.30$448.77

$2,112.00$831.00

Dividends+

Repurchases

$1,496.30$448.77

$2,112.00$831.00

Dividend P

ayout Ratio

84.77%

Cash P

aid as % of F

CF

E262.00%

RO

E - R

equired return-1.67%

11.49%20.90%

-21.59%

Aswath D

amodaran

180

BP

: Just Desserts!

Aswath D

amodaran

181

The Lim

ited: Sum

mary of D

ividend Policy:

1983-1992

Summ

ary of calculations

Average

Standard Deviation

Maxim

umM

inimum

Free C

F to E

quity($34.20)

$109.74$96.89

($242.17)

Dividends

$40.87$32.79

$101.36$5.97

Dividends+

Repurchases

$40.87$32.79

$101.36$5.97

Dividend P

ayout Ratio

18.59%

Cash P

aid as % of F

CF

E-119.52%

RO

E - R

equired return1.69%

19.07%29.26%

-19.84%

Aswath D

amodaran

182

Grow

th Firm

s and Dividends

QH

igh growth firm

s are sometim

es advised to initiate dividends becauseits increases the potential stockholder base for the com

pany (sincethere are som

e investors - like pension funds - that cannot buy stocksthat do not pay dividends) and, by extension, the stock price. D

o youagree w

ith this argument?

RY

es

RN

o

Why?

Aswath D

amodaran

183

A

pplication Test: A

ssessing your firms

dividend policy

QC

ompare your firm

s dividends to its FCFE

, looking at the last 5 yearsof inform

ation.

QB

ased upon your earlier analysis of your firms project choices, w

ouldyou encourage the firm

to return more cash or less cash to its ow

ners?

QIf you w

ould encourage it to return more cash, w

hat form should it

take (dividends versus stock buybacks)?

Aswath D

amodaran

184

Other A

ctions that affect Stock P

rices

QIn the case of dividends and stock buybacks, firm

s change the value ofthe assets (by paying out cash) and the num

ber of shares (in the case ofbuybacks).

QT

here are other actions that firms can take to change the value of their

stockholders equity.

Divestitures: T

hey can sell assets to another firm that can utilize them

more efficiently, and claim

a portion of the value.

Spin offs: In a spin off, a division of a firm is m

ade an independent entity.T

he parent company has to give up control of the firm

.

Equity carve outs: In an E

CO

, the division is made a sem

i-independententity. T

he parent company retains a controlling interest in the firm

.

Tracking Stock: W

hen tracking stock are issued against a division, theparent com

pany retains complete control of the division. It does not have

its own board of directors.

Aswath D

amodaran

185

Differences in these actions

Asset com

pletelycovenrted into cash

No cash for

transaction

Control fully lost

Parent com

panhy preservescontrol

Taxed on capital gains

No T

axes

Bondholders negatively

affected

Bondholders

unaffected

Divestitures

Spin offs

EC

OTracking stock

Divestitures

Spin offs

EC

OTracking stock

Divestitures

Spin offs

Divestitures

Tracking stock

EC

Os

Trackingstock

Spin offs

EC

O