Modul !! (2010-2011)

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Dividend Policy (Modul MKL 2010-2011)

DIVIDEND POLICY

BRIEF CONCEPT

Definition:

Dividend is the distribution of value to shareholders.

Dividend Policy:

What happens to the value of the firm as dividend is increased, holding everything else (capital budgets, borrowing) constant. Thus, it is a trade-off between retained earnings on one hand, and distributing cash or securities on the other.

Relevant Dates:

Record date : all person whose names are recorded as the stockholders on the date of record set by the directors receive a declared dividend at the specific future time. When stockholders buy stock after ex dividend rate,(2 business days to record date) do not receive the current dividend,because needs time to make bookkepping entries.

Payment date is the actual date on which the firm mails the dividend payment to the holders of record.

Types of Dividend Policy

The firm’s dividend policy must be formulated with two basic objectives in mind:

ü  Providing for sufficient financing

ü  Maximizing the wealth of firm’s owner.

There are three commonly used dividend policies :

1 CONSTANT-PAYOUT-RATIO DIVIDEN POLICY

Indicates the percentage of each dollar earned thet the firm distributes to the owners in the form of cash. Although its not recommended because will cause owners uncertain about the returns they can expect.

2. REGULAR DIVIDEN POLICY

Is based on the payment of a fixed-dollar dividend in each period.This policy provides the owners with generally positive information,thereby minimizing their uncertainty.

3. LOW-REGULAR-and-EXTRA DIVIDEN POLICY

Paying a low regular dividend,supplemented by an additional dividend when earnings are higher than normal in given period.

 OTHER FORMS OF DIVIDEND

1. STOCK DIVIDEND

Is the payment,to existing owners, of a dividend in the form of stock. It will not cause change in stockholders equity,funds have merely been shifted among stockholders equity accounts. It will cause lower per-share market value of firms’s stock.

2. STOCK SPLIT

Is method used to lower the market price of firm’s stock by increasing the number of share belonging each shareholders.

3. STOCK REPURCHASE

Firms repurchasing of outstanding common stock in the market place.

FACTORS AFFECTING DIVIDEND POLICY :

                                                                                               

1.      Legal constraints

2.      Contractual constraints

3.      Internal Constraint

4.      Growth prospects

5.      Owner Considerations

6.      Market Considerations

Leverage and Capital Structure (Modul MKL 2010-2011)

LEVERAGE AND CAPITAL STRUCTURE

BRIEF CONCEPT

Leverage results from the use of fixed-costs assets or funds to magnify returns to the firm’s owners.

Operating leverage is the potential use of fixed operating costs to magnify the effect of changes in sales on the firm’s earnings before interest and taxes.

Financial leverage is the potential use of fixed financial costs to magnify the effect of changes in earnings before interest and taxes on the firm’s earnings per share.

Business Risk and Financial Risk

Business risk is an uncertainty about future operating income (EBIT), determined by :

• Uncertainty about demand (sales)

• Uncertainty about output prices

• Uncertainty about costs

• Product, other types of liability

• Operating leverage 

Business risk depends on business factors such as competition, product liability, and operating leverage.

Financial risk is the additional risk concentrated on common stockholders as a result of financial leverage. 

Financial risk depens only on the types of securities issued.

• More debt, more financial risk.

• Concentrates business risk on stockholders.

OPTIMAL CAPITAL STRUCTURE

Capital structure is the mix of long-term debt and equity maintained by the firm.

Optimal Capital Structure - that mix of debt and equity which maximizes the value of the firm (maximizes stock prices) or minimizes the cost of capital (WACC).

 

where :

EBIT                   =  earning before interest and taxes

T                          = tax rate

NOPAT               = net operating profits after taxes

r_a                          = weighted average cost of capital

• Target Capital Structure is simply defined as the mix of debt, preferred stock and common equity that will optimize the company's stock price. As a company raises new capital it will focus on maintaining this target capital structure.

•  Pecking Order Theory is a theory that states companies prioritize their sources of financing (from internal financing to equity) according to the principle of least effort, or of least resistance, preferring to raise equity as a financing means of last resort. Hence, internal funds are used first, and when that is depleted, debt is issued, and when it is not sensible to issue any more debt, equity is issued. This theory maintains that businesses adhere to a hierarchy of financing sources and prefer internal financing when available, and debt is preferred over equity if external financing is required.

• Signalling theory is based on the assumption that information is not equally available to all parties at the same time, and that information asymmetry is the rule. Information asymmetries (see also asymmetry – issuer/investor) can result in very low valuations or a sub-optimum investment policy. Signalling theory states that corporate financial decisions are signals sent by the company's managers to investors in order to shake up these asymmetries. These signals are the cornerstone of financial communications policy.

Factors to consider when establishing the firm’s target capital structure :

1.  Industry average debt ratio

2.  TIE ratios under different scenarios

3.  Lender/rating agency attitudes

4.  Reserve borrowing on control

5.  Asset structure

6.  Effect of financing on control

7.  Expected tax rate

 

Stock Valuation (Modul MKL 2010-2011)

STOCK VALUATION

BRIEF CONCEPT

Expected return of stock

Basic stock value:

Common stock value:

a. Zero growth 

Where, Po       = value of common stock

            D₁        = initial dividend

            r_s          = required return of common stock

b. Constant Growth

 Where, P₀        = value of common stock

    D₁          = initial dividend

   r_s             = required return on common stock

   g          = constant rate of growth in dividends

c. Variabel Growth

Where, P₀        = value of common stock

D₀          = the most recent dividend

g₁         = initial dividend growth rate

g₂            = subsequent dividend growth rate

r_s             = required return of common stock

 n          = last year of initial growth period

  d. Free Cash Flow Value Entire Company

Where, Vs       = value of common stock

            Vc       = value of the entire company

            Vd       = market value of the firm’s debt

            Vp       = market value of the preferred stock

            FCF     = free cash flow expected at the end of year t

            r_a             = weighted average cost of capital

Other approach to common stock valuation

•  Book Value

• Liquidation Value   

• Price/earning multiple

 

Bond Valuation (Modul MKL 2010-2011)

BOND VALUATION

A.    Definition of Bond Valuation

Bond valuation means the process of determining the fair price of a bond. Bond valuation process:

Important terms in bond valuation:

• Bond, is the debt instrument indicated when a company (or government) borrows money from the public or banks (bondholders) and agrees to pay it back later.
• Par Value, The amount of money that the company borrows.
• Coupon Payments, This is like interest. The company makes regular payments to the bondholders, like every 6 months or every year.
• Indenture, The legal stuff. A written agreement between the company and the bond holder. They talk about how much the coupon payments will be, and when the money (par value) will be paid back to the bondholder.
• Maturity Date, date when the company pays the par value back to the bondholder.

Formula : 

Bo = (I x PVIFAi,n) + (M x PVIFi,n)

Semiannual coupon payment :

Bo = (I/2 x PVIFAi/2,nx2) + (M x PVIFi/2,nx2)

Where:

            Bo       : Value of the bond at the time zero

            I           : Annual interest paid in dollars

            n          : number of years maturity

            M         : par value in dollars

            rd         : required return on bond

Yield to maturity (YTM)

The rate of return that investors earn if they buy the bond at a specific price and hold it until maturity date.

Where:

            I           : Annual interest paid in dollar

            n          : number of years maturity

            M         : par value in dollars

            V         : market value

     Current Yield

    The cash return of the bond for the year, calculated by dividing the bond’s annual interest payment by its current price.

CY = I/V

     Where:

I           : Annual interest paid in dollars

V         : Market value

Criteria:

Discount	sell price < par value	M -Bo
	Required return > coupon interest rate
Premium	sell price > par value	Bo -M
	Required return < coupon interest rate
Par Value	sell price = par value  Required return = coupon interest rate	Bo = M