8L1u8nlnC CASP 1C 1PL

CWnL8S: ulvluLnu CLlC?

Companles donL have cash. 1hey hold cash for
Lhelr sLockholders.
Aswath Damodaran 1
2
llrsL rlnclples
Aswath Damodaran
2
The Investment Decision
Invest in assets that earn a
return greater than the
minimum acceptable hurdle
rate
The Financing Decision
Find the right kind of debt
for your rm and the right
mix of debt and equity to
fund your operations
The Dividend Decision
If you cannot nd investments
that make your minimum
acceptable rate, return the cash
to owners of your business
The hurdle rate
should reect the
riskiness of the
investment and
the mix of debt
and equity used
to fund it.
The return
should reect the
magnitude and
the timing of the
cashows as welll
as all side effects.
The optimal
mix of debt
and equity
maximizes rm
value
The right kind
of debt
matches the
tenor of your
assets
How much
cash you can
return
depends upon
current &
potential
investment
opportunities
How you choose
to return cash to
the owners will
depend on
whether they
prefer dividends
or buybacks
Maximize the value of the business (rm)
3
SLeps Lo Lhe ulvldend ueclslon.
Aswath Damodaran
3
Cashflow
from
Operations
Cashflows to Debt
(Principal repaid,
Interest
Expenses)
Cashflows from
Operations to
Equity Investors
Reinvestment back
into the business
Cash available
for return to
stockholders
Cash held back
by the company
Cash Paid out
Stock Buybacks
Dividends
How much did you borrow?
How good are your investment choices?
What is a reasonable cash balance?
What do your
stockholders prefer?
4
l. ulvldends are sucky
Aswath Damodaran
4
0.00
10.00
20.00
30.00
40.00
30.00
60.00
70.00
80.00
!"#"$%&$ ()*&+%, *- ./ 0123*&"%,
lncrease
uecrease
no change
5
1he lasL quarLer of 2008 puL sucklness Lo Lhe
LesL.. number of S& 300 companles LhaL.
Aswath Damodaran
5
Quarter Dividend Increase Dividend initiated Dividend decrease Dividend suspensions
Q1 2007 102 1 1 1
Q2 2007 63 1 1 5
Q3 2007 59 2 2 0
Q4 2007 63 7 4 2
Q1 2008 93 3 7 4
Q2 2008 65 0 9 0
Q3 2008 45 2 6 8
Q4 2008 32 0 17 10
6
ll. ulvldends Lend Lo follow earnlngs
Aswath Damodaran
6
0.00
20.00
40.00
60.00
80.00
100.00
120.00
?
e
a
r

1
9
6
0

1
9
6
1

1
9
6
2

1
9
6
3

1
9
6
4

1
9
6
3

1
9
6
6

1
9
6
7

1
9
6
8

1
9
6
9

1
9
7
0

1
9
7
1

1
9
7
2

1
9
7
3

1
9
7
4

1
9
7
3

1
9
7
6

1
9
7
7

1
9
7
8

1
9
7
9

1
9
8
0

1
9
8
1

1
9
8
2

1
9
8
3

1
9
8
4

1
9
8
3

1
9
8
6

1
9
8
7

1
9
8
8

1
9
8
9

1
9
9
0

1
9
9
1

1
9
9
2

1
9
9
3

1
9
9
4

1
9
9
3

1
9
9
6

1
9
9
7

1
9
9
8

1
9
9
9

2
0
0
0

2
0
0
1

2
0
0
2

2
0
0
3

2
0
0
4

2
0
0
3

2
0
0
6

2
0
0
7

2
0
0
8

2
0
0
9

2
0
1
0

2
0
1
1

2
0
1
2

2
0
1
3

S& S00: D|v|dends and Larn|ngs - 1960 to 2013
Larnlngs
ulvldends
lll. Are aecLed by Lax laws.
In 2003 In the |ast quarter of 2012
! As Lhe posslblllLy of Lax
raLes reverung back Lo
pre-2003 levels rose, 233
companles pald ouL $31
bllllon ln dlvldends.
! Cf Lhese companles, 101
had lnslder holdlngs ln
excess of 20 of Lhe
ouLsLandlng sLock.
8
lv. More and more rms are buylng back sLock,
raLher Lhan pay dlvldends...
Aswath Damodaran
8
$-
$100,000.00
$200,000.00
$300,000.00
$400,000.00
$500,000.00
$600,000.00
1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
$

D
i
v
i
d
e
n
d
s

&

B
u
y
b
a
c
k
s

Year
Stock Buybacks and Dividends: Aggregate for US Firms - 1989-2013
Stock Buybacks Dividends
9
v. And Lhere are dlerences across counLrles.
Aswath Damodaran
9
10
Measures of ulvldend ollcy
Aswath Damodaran
10
! ulvldend ayouL = ulvldends/ neL lncome
! Measures Lhe percenLage of earnlngs LhaL Lhe company
pays ln dlvldends
! lf Lhe neL lncome ls negauve, Lhe payouL rauo cannoL be
compuLed.
! ulvldend ?leld = ulvldends per share/ SLock prlce
! Measures Lhe reLurn LhaL an lnvesLor can make from
dlvldends alone
! 8ecomes parL of Lhe expecLed reLurn on Lhe lnvesLmenL.
11
ulvldend ayouL 8auos
Aswath Damodaran
11
0.00
2.00
4.00
6.00
8.00
10.00
12.00
14.00
16.00
18.00
0-10 10-20 20-30 30-40 40-30 30-60 60-70 70-80 70-90 90-100 >100
D|v|dend ayout kanos |n 2014
Clobal
uS
12
ulvldend ?lelds: !anuary 2013
Aswath Damodaran
12
0.00
2.00
4.00
6.00
8.00
10.00
12.00
14.00
16.00
18.00
D|v|dend |e|ds |n 2014
Clobal
uS
Aswath Damodaran 13
14
ulvldend ?lelds and ayouL 8auos: CrowLh
Classes
Aswath Damodaran
14
0.00
0.30
1.00
1.30
2.00
2.30
3.00
3.30
4.00
0.00
3.00
10.00
13.00
20.00
23.00
30.00
33.00
40.00
43.00
30.00
0-3 3-3 3-10 10-13 13-20 20-23 >23
!"#"$%&$ 4"%5$, *&$ 6*718- 9*:1,; <7 =>1?-) (5*,,
ulvldend ayouL rauo
ulvldend ?leld
15
ulvldend ollcy: ulsney, vale, 1aLa MoLors,
8aldu and ueuLsche 8ank
Aswath Damodaran
15
Disney Vale Tata Motors Baidu Deutsche Bank
Dividend Yield - Last 12 months 1.09% 6.56% 1.31% 0.00% 1.96%
Dividend Payout ratio - Last 12 months 21.58% 113.45% 16.09% 0.00% 362.63%
Dividend Yield - 2008-2012 1.17% 4.01% 1.82% 0.00% 3.14%
Dividend Payout - 2008-2012 17.11% 37.69% 15.53% 0.00% 37.39%

16
1hree Schools Cf 1houghL Cn ulvldends
1. lf Lhere are no Lax dlsadvanLages assoclaLed wlLh
dlvldends & companles can lssue sLock, aL no lssuance
cosL, Lo ralse equlLy, whenever needed
D|v|dends do not mauer, and d|v|dend po||cy does not aect
va|ue.
2. lf dlvldends creaLe a Lax dlsadvanLage for lnvesLors
(relauve Lo caplLal galns)
D|v|dends are bad, and |ncreas|ng d|v|dends w||| reduce va|ue
3. lf dlvldends creaLe a Lax advanLage for lnvesLors
(relauve Lo caplLal galns) and/or sLockholders llke
dlvldends
D|v|dends are good, and |ncreas|ng d|v|dends w||| |ncrease va|ue
Aswath Damodaran
17
1he balanced vlewpolnL
Aswath Damodaran
17
! lf a company has excess cash, and few good
lnvesLmenL opporLunlues (nv>0), reLurnlng money
Lo sLockholders (dlvldends or sLock repurchases) ls
good.
! lf a company does noL have excess cash, and/or has
several good lnvesLmenL opporLunlues (nv>0),
reLurnlng money Lo sLockholders (dlvldends or sLock
repurchases) ls bad.
18
1he ulvldends donL mauer school
1he Mlller Modlgllanl PypoLhesls
Aswath Damodaran
18
! 1he Mlller-Modlgllanl PypoLhesls: ulvldends do noL aecL value
! 8asls:
! lf a rm's lnvesLmenL pollcles (and hence cash ows) don'L change, Lhe value of Lhe
rm cannoL change as lL changes dlvldends.
! lf a rm pays more ln dlvldends, lL wlll have Lo lssue new equlLy Lo fund Lhe same
pro[ecLs. 8y dolng so, lL wlll reduce expecLed prlce appreclauon on Lhe sLock buL lL
wlll be oseL by a hlgher dlvldend yleld.
! lf we lgnore personal Laxes, lnvesLors have Lo be lndlerenL Lo recelvlng elLher
dlvldends or caplLal galns.
! underlylng Assumpuons:
(a) 1here are no Lax dlerences Lo lnvesLors beLween dlvldends and caplLal galns.
(b) lf companles pay Loo much ln cash, Lhey can lssue new sLock, wlLh no oLauon cosLs
or slgnallng consequences, Lo replace Lhls cash.
(c) lf companles pay Loo llule ln dlvldends, Lhey do noL use Lhe excess cash for bad
pro[ecLs or acqulsluons.
19
ll. 1he ulvldends are bad school: And Lhe
evldence Lo back Lhem up.
Aswath Damodaran
19
0.00
10.00
20.00
30.00
40.00
30.00
60.00
70.00
80.00
90.00
100.00
1
9
1
6

1
9
1
8

1
9
2
0

1
9
2
2

1
9
2
4

1
9
2
6

1
9
2
8

1
9
3
0

1
9
3
2

1
9
3
4

1
9
3
6

1
9
3
8

1
9
4
0

1
9
4
2

1
9
4
4

1
9
4
6

1
9
4
8

1
9
5
0

1
9
5
2

1
9
5
4

1
9
5
6

1
9
5
8

1
9
6
0

1
9
6
2

1
9
6
4

1
9
6
6

1
9
6
8

1
9
7
0

1
9
7
2

1
9
7
4

1
9
7
6

1
9
7
8

1
9
8
0

1
9
8
2

1
9
8
4

1
9
8
6

1
9
8
8

1
9
9
0

1
9
9
2

1
9
9
4

1
9
9
6

1
9
9
8

2
0
0
0

2
0
0
2

2
0
0
4

2
0
0
6

2
0
0
8

2
0
1
0

2
0
1
1

2
0
1
3

@*A >*-%, 1& $"#"$%&$, *&$ 0*3"-*5 +*"&,B ./
ulvldend Lax raLe CaplLal galns Lax raLe
20
WhaL do lnvesLors ln your sLock Lhlnk abouL
dlvldends? Clues on Lhe ex-dlvldend day!
Aswath Damodaran
20
! Assume LhaL you are Lhe owner of a sLock LhaL ls approachlng an ex-
dlvldend day and you know LhaL dollar dlvldend wlLh cerLalnLy. ln
addluon, assume LhaL you have owned Lhe sLock for several years.
= rlce aL whlch you boughL Lhe sLock a whlle back

b
= rlce before Lhe sLock goes ex-dlvldend

a
=rlce aer Lhe sLock goes ex-dlvldend
u = ulvldends declared on sLock
L
o
, L
cg
= 1axes pald on ordlnary lncome and caplLal galns respecuvely
Ex-dividend day
Dividend = $ D
Initial buy
At $P
P
b
P
a

21
Cashows from Selllng around Lx-ulvldend uay
Aswath Damodaran
21
! 1he cash ows from selllng before ex-dlvldend day are:

b
- (
b
- ) L
cg

! 1he cash ows from selllng aer ex-dlvldend day are:

a
- (
a
- ) L
cg
+ u(1-L
o
)
! Slnce Lhe average lnvesLor should be lndlerenL
beLween selllng before Lhe ex-dlvldend day and selllng
aer Lhe ex-dlvldend day -

b
- (
b
- ) L
cg
=
a
- (
a
- ) L
cg
+ u(1-L
o
)
! Some baslc algebra leads us Lo Lhe followlng:
!
P
b
"P
a
D
=
1" t
o
1" t
cg
22
lnLuluve lmpllcauons
Aswath Damodaran
22
! 1he relauonshlp beLween Lhe prlce change on Lhe ex-
dlvldend day and Lhe dollar dlvldend wlll be deLermlned by
Lhe dlerence beLween Lhe Lax raLe on dlvldends and Lhe Lax
raLe on caplLal galns for Lhe Lyplcal lnvesLor ln Lhe sLock.
Tax Rates Ex-dividend day behavior
If dividends and capital gains are
taxed equally
Price change = Dividend
If dividends are taxed at a higher
rate than capital gains
Price change < Dividend
If dividends are taxed at a lower
rate than capital gains
Price change > Dividend
23
1he emplrlcal evldence.
Aswath Damodaran
23
- Crdlnary Lax raLe = 70
- CaplLal galns raLe = 28
- rlce change as of ulvldend = 78
1966-1969
- Crdlnary Lax raLe = 30
- CaplLal galns raLe = 20
- rlce change as of ulvldend = 83
1981-1983
- Crdlnary Lax raLe = 28
- CaplLal galns raLe = 28
- rlce change as of ulvldend = 90
1986-1990
24
ulvldend ArblLrage
Aswath Damodaran
24
! Assume LhaL you are a Lax exempL lnvesLor, and LhaL
you know LhaL Lhe prlce drop on Lhe ex-dlvldend day
ls only 90 of Lhe dlvldend. Pow would you explolL
Lhls dlerenual?
a. lnvesL ln Lhe sLock for Lhe long Lerm
b. Sell shorL Lhe day before Lhe ex-dlvldend day, buy on Lhe
ex-dlvldend day
c. 8uy [usL before Lhe ex-dlvldend day, and sell aer.
d. ______________________________________________
25
Lxample of dlvldend capLure sLraLegy wlLh Lax
facLors
Aswath Damodaran
25
! x?Z company ls selllng for $30 aL close of Lradlng May 3.
Cn May 4, x?Z goes ex-dlvldend, Lhe dlvldend amounL ls
$1. 1he prlce drop (from pasL examlnauon of Lhe daLa) ls
only 90 of Lhe dlvldend amounL.
! 1he Lransacuons needed by a Lax-exempL u.S. penslon
fund for Lhe arblLrage are as follows:
! 1. 8uy 1 mllllon shares of x?Z sLock cum-dlvldend aL $30/share.
! 2. WalL ull sLock goes ex-dlvldend, Sell sLock for $49.10/share
(30 - 1* 0.90)
! 3. CollecL dlvldend on sLock.
! neL proL = - 30 mllllon + 49.10 mllllon + 1 mllllon =
$0.10 mllllon
26
1wo bad reasons for paylng dlvldends
1. 1he blrd ln Lhe hand fallacy
Aswath Damodaran
26
! ArgumenL: ulvldends now are more cerLaln Lhan
caplLal galns laLer. Pence dlvldends are more
valuable Lhan caplLal galns. SLocks LhaL pay
dlvldends wlll Lherefore be more hlghly valued Lhan
sLocks LhaL do noL.
! CounLer: 1he approprlaLe comparlson should be
beLween dlvldends Loday and prlce appreclauon
Loday. 1he sLock prlce drops on Lhe ex-dlvldend day.
27
2. We have excess cash Lhls year.
Aswath Damodaran
27
! ArgumenL: 1he rm has excess cash on lLs hands Lhls
year, no lnvesLmenL pro[ecLs Lhls year and wanLs Lo
glve Lhe money back Lo sLockholders.
! CounLer: So why noL [usL repurchase sLock? lf Lhls ls
a one-ume phenomenon, Lhe rm has Lo conslder
fuLure nanclng needs. 1he cosL of ralslng new
nanclng ln fuLure years, especlally by lssulng new
equlLy, can be sLaggerlng.
28
1he CosL of 8alslng CaplLal
Aswath Damodaran
28
0.00%
5.00%
10.00%
15.00%
20.00%
25.00%
Under $1 mil $1.0-1.9 mil $2.0-4.9 mil $5.0-$9.9 mil $10-19.9 mil $20-49.9 mil $50 mil and over
C
o
s
t

a
s

%

o
f

f
u
n
d
s

r
a
i
s
e
d

Size of Issue
Figure 10.12: Issuance Costs for Stocks and Bonds
Cost of Issuing bonds Cost of Issuing Common Stock
29
1hree good reasons for paylng dlvldends.
Aswath Damodaran
29
! CllenLele LecL: 1he lnvesLors ln your company llke
dlvldends.
! 1he Slgnalllng SLory: ulvldends can be slgnals Lo Lhe
markeL LhaL you belleve LhaL you have good cash
ow prospecLs ln Lhe fuLure.
! 1he WealLh Approprlauon SLory: ulvldends are one
way of Lransferrlng wealLh from lenders Lo equlLy
lnvesLors (Lhls ls good for equlLy lnvesLors buL bad
for lenders)
30
1. 1he CllenLele LecL
1he sLrange case of Cluzens uullLy
Aswath Damodaran
30
Class A
shares pay
cash
dividend

Class B
shares offer
the same
amount as a
stock
dividend &
can be
converted to
class A
shares
31
Lvldence from Canadlan rms
Aswath Damodaran
31
Company Premium for cash dividend shares
Consolidated Bathurst + 19.30%
Donfasco + 13.30%
Dome Petroleum + 0.30%
Imperial Oil +12.10%
Newfoundland Light & Power + 1.80%
Royal Trustco + 17.30%
Stelco + 2.70%
TransAlta +1.10%
Average across companies + 7.54%
32
A cllenLele based explanauon
Aswath Damodaran
32
! 8asls: lnvesLors may form cllenLeles based upon
Lhelr Lax brackeLs. lnvesLors ln hlgh Lax brackeLs may
lnvesL ln sLocks whlch do noL pay dlvldends and
Lhose ln low Lax brackeLs may lnvesL ln dlvldend
paylng sLocks.
! Lvldence: A sLudy of 914 lnvesLors' poruollos was
carrled ouL Lo see lf Lhelr poruollo posluons were
aecLed by Lhelr Lax brackeLs. 1he sLudy found LhaL
! (a) Clder lnvesLors were more llkely Lo hold hlgh dlvldend
sLocks and
! (b) oorer lnvesLors Lended Lo hold hlgh dlvldend sLocks
8esulLs from 8egresslon: CllenLele LecL
u l v l d e n d ? l e l d
L
= a + b !
L
+ c A g e
L
+ d l n c o m e
L
+ e u l f f e r e n L l a l 1 a x 8 a L e
L
+ "
L
V a r | a b | e C o e f f | c | e n t I m p | | e s
C o n s L a n L 4 . 2 2
8 e L a C o e f f l c l e n L - 2 . 1 4 3 P l g h e r b e L a s L o c k s p a y l o w e r d l v l d e n d s .
A g e / 1 0 0 3 . 1 3 1 l l r m s w l L h o l d e r l n v e s L o r s p a y h l g h e r
d l v l d e n d s .
l n c o m e / 1 0 0 0 - 3 . 7 2 6 l l r m s w l L h w e a l L h l e r l n v e s L o r s p a y l o w e r
d l v l d e n d s .
u l f f e r e n L l a l 1 a x 8 a L e - 2 . 8 4 9 l f o r d l n a r y l n c o m e l s L a x e d a L a h l g h e r r a L e
L h a n c a p l L a l g a l n s , L h e f l r m p a y s l e s s
d l v l d e n d s .
34
ulvldend ollcy and CllenLele
Aswath Damodaran
34
! Assume LhaL you run a phone company, and LhaL you have
hlsLorlcally pald large dlvldends. ?ou are now plannlng Lo
enLer Lhe Lelecommunlcauons and medla markeLs. Whlch of
Lhe followlng paLhs are you mosL llkely Lo follow?
a. Courageously announce Lo your sLockholders LhaL you plan
Lo cuL dlvldends and lnvesL ln Lhe new markeLs.
b. Conunue Lo pay Lhe dlvldends LhaL you used Lo, and defer
lnvesLmenL ln Lhe new markeLs.
c. Conunue Lo pay Lhe dlvldends LhaL you used Lo, make Lhe
lnvesLmenLs ln Lhe new markeLs, and lssue new sLock Lo
cover Lhe shoruall
d. CLher
35
2. ulvldends send a slgnal
lncreases ln dlvldends are good news..
Aswath Damodaran
35
36
8uL hlgher or new dlvldends may slgnal
bad news (noL good)
Aswath Damodaran
36
0.00
3.00
10.00
13.00
20.00
23.00
30.00
33.00
40.00
43.00
-4 -3 -2 -1 1 2 3 4
A
n
n
u
a
|

L
a
r
n
|
n
g
s

G
r
o
w
t
h

k
a
t
e

ear re|anve to d|v|dend |n|nanon (8efore and aher)
D|v|dend In|nanons and Larn|ngs Growth
8oLh dlvldend lncreases and decreases are
becomlng less lnformauve.
-6.00
-3.00
-4.00
-3.00
-2.00
-1.00
0.00
1.00
1962-1974 1973-1987 1988-2000
Market Reaction to Dividend Changes over time: US companies
ulvldend lncreases
ulvldend uecreases
3. ulvldend lncreases may be good for
sLocks. buL bad for bonds..
-2
-1.5
-1
-0.5
0
0.5
t:-
15
-12 -9 -6 -3 0 3 6 9 12 15
CAR (Div Up)
CAR (Div down)
EXCESS RETURNS ON STOCKS AND BONDS AROUND DIVIDEND CHANGES
Day (0: Announcement date)
CAR
Bond price drops
Stock price rises
39
WhaL managers belleve abouL dlvldends.
Aswath Damodaran
39
40
llrsL rlnclples
Aswath Damodaran
40
The Investment Decision
Invest in assets that earn a
return greater than the
minimum acceptable hurdle
rate
The Financing Decision
Find the right kind of debt
for your rm and the right
mix of debt and equity to
fund your operations
The Dividend Decision
If you cannot nd investments
that make your minimum
acceptable rate, return the cash
to owners of your business
The hurdle rate
should reect the
riskiness of the
investment and
the mix of debt
and equity used
to fund it.
The return
should reect the
magnitude and
the timing of the
cashows as welll
as all side effects.
The optimal
mix of debt
and equity
maximizes rm
value
The right kind
of debt
matches the
tenor of your
assets
How much
cash you can
return
depends upon
current &
potential
investment
opportunities
How you choose
to return cash to
the owners will
depend on
whether they
prefer dividends
or buybacks
Maximize the value of the business (rm)