IFM lecture 9
IFM lecture 9 valuation and capital for levered firm / dividends and payouts
IFM lecture 9 valuation and capital for levered firm / dividends and payouts
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Kartei Details
| Karten | 22 |
|---|---|
| Sprache | English |
| Kategorie | BWL |
| Stufe | Universität |
| Erstellt / Aktualisiert | 18.01.2022 / 21.01.2022 |
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why are projects evaluated
- when firm relocates, municipalities / regions create package (tax credits, subsidized debt)
- With subsidized debt from government or region, firm can borrow at low rate
3 methods to evaluate financial benefits of debt subsidies
- Adjusted present value
- Flow to equity approach
- WACC method
adjusted present value
- Value of levered firm (APV) is value of project to an unlevered firm (NPV) + net present value of financing side effects (NPVF) à APV = NPV + NPVF
- Side effects summarized by NPVF
- Tax subsidy to debt
- Costs of financing distress
- Costs of issuing new securities
- Subsidies to debt financing
- With a negative NCP, and all equity firm would reject the project
- But the NPV of the project under leverage = adjusted present value (APV)
- Positive APV: a levered firm can accept the project
- Using debt enables saving taxes
flow to equity
- FTE is alternative capital budgeting approach
- Formula: cash flow from project to equity-holders of levered firm ÷ cost of equity capital (Rs)
- Steps
- Calculated levered cash flow (LCF): cash inflows – cash costs – interest (= income after interest) – corporate tax
- Calculate Rs
- Valuation of levered cash flow: NPC is difference between present value of LFC and investment not borrowed
weighted average cost of capital
- Project of levered firms are concurrently financed with both equity and debt
- Cost of capital = weighted average of cost of equity and cost of debt with corporate taxes included
dividend, def
Dividend = distribution from earnings
Most common: form of cash, 2 or 4 x p.y.
types of dividends:
stock dividend, dividend per share, dividend yield, dividend payout, stock split
- Stock dividend: paid in shares of equity
- Increases number of shares outstanding, reducing value of each share
- Dividend per share: amount of dividend expressed as currency per share
- Dividend yield: amount of dividend expressed as % of market price
- Dividend payout: amount of dividend expressed as % of earnings per share
- Stock split: when firms declare stock split, increases number of shares outstanding
- Resembles stock dividend, but usually larger
standard method of cash dividend
- Declaration date: the board of directors declares a payment of dividends
- Record date: the declared dividends are distributable to shareholders of record
- Ex-dividend date: share of equity becomes ex-dividend on the date the seller is entitled to keep the dividend
- Payment date: dividend cheques are mailed to shareholders of record
relevance of dividend policy
- The change in dividend policy does not affect the value of a share of equity
- Managers can achieve any payout along the diagonal line
- An individual investor can achieve any net cash payout along the diagonal line
- Investors can make homemade dividends
share repurchases
- Open market purchases: firm purchases own equity as anyone would by shares, not revealing itself
- Tender offer: firm announces to all shareholders that it intends to buy back x shares at x price
- Targeted repurchase: repurchase shares from specific shareholder, to
- Buy him out at lower price
- Lower legal fees
- Avoid unfavorable takeover to management
in a perfect market
Why choose repurchase over dividends (5)
- Flexibility: dividends as commitments
- Executive compensation: repurchase increases share price -> share options will have greater value
- Offset to dilution: offset the increase of shares outstanding coming from share options
- Undervaluation: repurchase when equity is undervalued
- Taxes: repurchases offer tax advantage over dividends
when should a firm issue equity to pay dividend and when not?
- If a firm does not have sufficient cash to pay a dividend in a world of personal taxes, it should not issue equity to pay dividends (loses money to government)
- But if company has large and steady degree of cash flow for many years, it can issue equity if cash flow dries up
- Shareholders prefer dividend stability
if a firm has excess cash after selecting projects with positive npv:
4 possibilities
- Select additional capital budgeting projects with negative NPV: keep funds in firm
- Acquire other companies: acquire profitable assets
- Purchase financial assets: dividend payout decision depends on personal and corporate tax rates
- Repurchase shares: reasonable alternative. But often penalized by authorities because risk of illegal price manipulation
3 factors favouring high-dividend policy
with pros and cons
- desire for current income
- Pro: individuals desire current income -> bid up share price if dividend rise, bid down share price if dividend falls
- Con: individual could sell off shares to provide necessary funds to buy higher cash flow
- behavioral finance
- Self-control: avoid selling off too much to consume more than earlier years, leaving little for later years
- -> increased dividends rather than share purchases
- Investors would sell shares that firms repurchase, but selling involves too much leeway (derive)
- agency costs
- Pro: by paying dividends = to surplus cash flow, firm reduces managers’ ability to squander firm’s resources (vs bondholders or shareholders)
- Con: also applies to share repurchases (could profit managers or board directors at expense of others)
information content of dividends
- Share price rises when firm announces dividend increase, falls when announced dividend reduction
- Dividend increase = market signal that firm is expected to do well
- Information content effect of dividend: rise in share price follows the dividend signal
dividend signaling
- Managers can increase dividends to make market think that cash flows will be higher
- Problems
- There are costs to raising dividends
- The market will learn, share price will fall below its original level as punishment
- It is not enough for manager to set dividend policy to maximize true value of firm -> consider effect of dividend policy on current share price
clientele effect
- Clientele effect: the two sets of factors can cancel each other out
- Personal taxes favor low-dividend policy
- Other factors favor high dividends
- A firm cannot boost its share price by paying high dividends if there are already enough high-dividend firms to satisfy investors -> need unsatisfied clientele
- Equities should attract clienteles based on dividend yield
- Clientele effect can lead demand for dividend-paying shares to shift to new equilibrium, if proportion of dividend-paying firms increases or decreases
- Some companies are mispriced
catering theory of dividends
- Catering theory of dividends: managers will respond rationally to time variation in investor demand for dividends by modifying their firm’s dividend policy
- With low demand for dividend-paying shares, dividend increase will not lead to positive price reaction
- Dividend omission can have more positive market response
stock split
- Stock or share dividend: dividend paid out in shares of equity
- Stock split: stock dividend expressed as ratio
- Stock splits and dividends leave value of form either unaffected, increased or decreased
- Difficult to determine
- Benchmark case: stock splits or dividends do not change wealth of shareholder or wealth of firm
popular trading range
- Security has a proper trading range
- When priced above: investors don’t have funds to buy unit of 100 shares
- Buy fewer = higher commissions
- Con: in reality, trading activities increased, individual share price is of little concern
- -> Large share prices don’t cause problems, stocks splits decrease liquidity of firm’s shares
reverse split: def and reasons
- Reverse split: ex one-for-five reverse split, each investor exchanges 5 old shares for a new share (no real effect)
- Reasons for reverse splits
- Less transaction costs to shareholder
- Better liquidity & marketability of firm
- Shares sold below a certain level are not considered respectable
- Bring share price up to minimum requirements
