Introductory Corporate Finance: Dividend Policy - Dividend Payment, Procedure Declaration Date Ex-Dividend Date Record Date Payment Date

What This Is

Dividend payment procedure is a critical concept in corporate finance, as it affects shareholders' returns and a company's ability to retain earnings. The procedure involves four key dates: declaration date, ex-dividend date, record date, and payment date. For example, consider a company like Apple (AAPL) that declares a quarterly dividend of $0.82 per share on January 10th. The ex-dividend date is January 12th, the record date is January 13th, and the payment date is February 10th. Shareholders who own the stock on the record date will receive the dividend payment.

Key Formulas & Models

• Dividend Yield (DY) = Annual Dividend per Share / Current Stock Price – measures the ratio of dividend payments to stock price.
  • DY = Annual Dividend per Share / Current Stock Price
  • Interpretation: Higher dividend yield indicates higher dividend payments relative to stock price.
• Dividend Payout Ratio (DPR) = Dividend per Share / Earnings per Share (EPS) – measures the proportion of earnings paid out as dividends.
  • DPR = Dividend per Share / EPS
  • Interpretation: Higher dividend payout ratio indicates higher dividend payments relative to earnings.
• Dividend Growth Rate (DGR) = (Dividend per Share, t+1 / Dividend per Share, t)^(1/t) – measures the rate of change in dividend payments.
  • DGR = (Dividend per Share, t+1 / Dividend per Share, t)^(1/t)
  • Interpretation: Higher dividend growth rate indicates increasing dividend payments.
• Sustainable Growth Rate (SGR) = ROE x (1 - Retention Ratio) – measures the rate at which a company can sustainably grow its earnings.
  • SGR = ROE x (1 - Retention Ratio)
  • Interpretation: Higher sustainable growth rate indicates higher potential for earnings growth.
• Dividend Irrelevance Theorem (DIT) = DOL = (1 + g) / (r - g) – measures the degree to which dividend payments affect stock price.
  • DIT = DOL = (1 + g) / (r - g)
  • Interpretation: Higher dividend irrelevance theorem indicates lower sensitivity of stock price to dividend payments.

Step-by-Step Calculation

1. Determine the dividend per share by dividing the total dividend payment by the number of outstanding shares.
2. Calculate the dividend yield by dividing the dividend per share by the current stock price.
3. Calculate the dividend payout ratio by dividing the dividend per share by the earnings per share.
4. Calculate the dividend growth rate by taking the natural logarithm of the ratio of dividend per share at time t+1 to dividend per share at time t, and then multiplying by 100.
5. Calculate the sustainable growth rate by multiplying the return on equity (ROE) by the retention ratio (1 - dividend payout ratio).

Common Mistakes

• Mistake: Using book value instead of market value for WACC.
  • Correction: Use market value for WACC to reflect current market conditions.
  • Counterexample: If a company has a market value of $100 billion and a book value of $50 billion, using book value would result in an incorrect WACC.
• Mistake: Ignoring flotation costs when calculating WACC.
  • Correction: Include flotation costs in WACC to reflect the true cost of capital.
  • Counterexample: If a company has a flotation cost of 5% and a market value of $100 billion, ignoring flotation costs would result in an incorrect WACC.
• Mistake: Confusing sunk cost with opportunity cost.
  • Correction: Use opportunity cost to reflect the true cost of a decision.
  • Counterexample: If a company has a sunk cost of $10 million, using opportunity cost would result in a more accurate decision.

Exam / CFA Tips

• Tip: Be able to distinguish between dividend irrelevance theorem and dividend growth rate.
  • Explanation: Dividend irrelevance theorem measures the degree to which dividend payments affect stock price, while dividend growth rate measures the rate of change in dividend payments.
• Tip: Be able to calculate sustainable growth rate using ROE and retention ratio.
  • Explanation: Sustainable growth rate measures the rate at which a company can sustainably grow its earnings, and can be calculated using ROE and retention ratio.
• Tip: Be able to distinguish between WACC and cost of equity.
  • Explanation: WACC measures the weighted average cost of capital, while cost of equity measures the cost of equity capital.

Quick Practice Problem

A company has EBIT of $10 million, interest of $2 million, and tax of 25%. Calculate the dividend payout ratio.

Answer: 0.5 Explanation: Dividend payout ratio = (EBIT - Interest) / EBIT = ($10 million - $2 million) / $10 million = 0.5

Last-Minute Cram Sheet

• Dividend Yield (DY) = Annual Dividend per Share / Current Stock Price
• Dividend Payout Ratio (DPR) = Dividend per Share / Earnings per Share (EPS)
• Dividend Growth Rate (DGR) = (Dividend per Share, t+1 / Dividend per Share, t)^(1/t)
• Sustainable Growth Rate (SGR) = ROE x (1 - Retention Ratio)
• Dividend Irrelevance Theorem (DIT) = DOL = (1 + g) / (r - g)
• WACC = wd × rd(1-T) + wps × rps + we × re
• Cost of Equity = rRF +-× (rM - rRF)
• Return on Equity (ROE) = Net Income / Total Equity
• Retention Ratio = 1 - Dividend Payout Ratio
• In M&M Proposition I (no taxes), firm value is independent of capital structure – but with taxes, value increases with debt due to the interest tax shield