CFA Level I Corporate Finance

Dividends and Share Repurchases: Basics

www.irfanullah.co

Contents
1. Introduction
2. Dividends: Forms

3. Dividends: Payment Chronology

4. Share Repurchases
5. Concluding Remarks (not mentioned in learning objectives)
www.irfanullah.co

1. Introduction
Owners/ Equity holders

$$$

Dividends
Share Repurchases
$$$

www.irfanullah.co

2. Dividends: Forms
1. Regular Cash Dividends
2. Extra or Special (Irregular) Dividends

Shareholders
get money

3. Liquidating Dividends
4. Stock Dividends

Shareholders
get more shares

5. Stock Splits
www.irfanullah.co

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)

www.irfanullah.co

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
www.irfanullah.co

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

Other types of splits are also possible (Example 2)

Help companies keep share price in a certain range

www.irfanullah.co

Academic research suggests that

market value tends to increase
because dividends and splits are taken
as a positive signal. If earnings dont
increase market value returns to
earlier level.
7

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

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.

www.irfanullah.co

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

www.irfanullah.co

3. Dividends: Payment Chronology

Declaration
Date

Ex-Dividend
Date

First day that stock

trades without
dividend

Holder-of-record
Date

Payment
Date

Typically two days after ex-dividend date;

shareholder listed in company records will be
deemed to have ownership of the shares for
purposes of receiving upcoming dividend

Examples 3 and 4
www.irfanullah.co

10

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
www.irfanullah.co

11

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

www.irfanullah.co

12

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.

www.irfanullah.co

13

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?

www.irfanullah.co

14

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 = 20

Book value of equity = $10 million

Company Y: 1 million shares, P = 20

Book value of equity = $30 million

Stock Price > Original BVPS BVPS down

Stock Price < Original BVPS BVPS up

www.arifirfanullah.com

15

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.

www.irfanullah.co

16

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

www.irfanullah.co

17

Conclusion
Read summary
Review learning objectives

Examples are good

Practice problems: good but not enough
Practice questions from other sources
www.irfanullah.co

18