Module 4 – SLP

Capital Structure and Dividends

Analyzing the Dividend Policies of Various Companies

Please recall the company that you selected for the Module 1 SLP. Please review the company’s dividends over the past three years.  Then, answer the following questions in Word (except for the Excel portion specifically noted): 

What has occurred with company’s dividend payout, dividend yield, and dividend per share over the past three years?  Do you have any explanations for what has occurred? 

How does your selected company’s dividend payout, dividend yield, and dividend per share compare to other companies in its industry?  Has the company’s dividend strategy been similar to other companies in its industry?  

You are now to use Excel and plot your selected company’s earnings and dividends over the past three years.  Do you notice any patterns? 

What is your estimate for your company’s dividend per share next year?  Please justify why you made that decision. 

Now locate a company that has reduced or eliminated its common stock cash dividend over the past year.  Why did the company reduce or eliminate its dividend?  What has happened to the company’s stock price over the year?

SLP Assignment Expectations

You are expected to: 

• Describe the purpose of the report and provide a conclusion. An introduction and a conclusion are important because many busy individuals in the business environment may only read the first and the last paragraph. If those paragraphs are not interesting, they never read the body of the paper.
• Answer the SLP Assignment question(s) clearly and provide necessary details.
• Write clearly and correctly—that is, no poor sentence structure, no spelling and grammar mistakes, and no run-on sentences.
• Provide citations to support your argument and references on a separate page. (All the sources that you listed in the references section must be cited in the paper.) Use APA format to provide citations and references.
• Type and double-space the paper.

Whenever appropriate, please use Excel to show supporting computations in an appendix, present financial information in tables, and use the data computed to answer follow-up questions.  In finance, in addition to being able to write well, it’s important to present information in a professional manner and to analyze financial information. This is part of the assignment expectations and will be considered for grading purposes.

Module 4 – Background

Capital Structure and Dividends

Capital Structure and Dividend Policy Podcast. (2014). Pearson Learning Solutions, New York, NY.

Capital Structure and Dividend Policy Interactive Video. (2014).  Pearson Learning Solutions, New York, NY.

Review these website links:

Damodaran, A. (2005). Finding the right financing mix: The capital structure decision. Retrieved June 2014 from http://pages.stern.nyu.edu/~adamodar/pdfiles/cfovhds/capstr.pdf

Harvey, C. (1995). WWWFinance: capital structure and payout policies. Retrieved June 2014 from http://www.duke.edu/~charvey/Classes/ba350/capstruc/capstruc.htm

Peavler, R. (2012). Debt and equity financing. Retrieved June 2014 from http://bizfinance.about.com/od/generalinformatio1/a/debtequityfin.htm

There are advantages and disadvantages to having debt in a corporation’s capital structure.

Corporations get a tax deduction  from the interest paid on debt.  On the other hand, dividends are not tax deductible.  This helps to reduce the cost of debt since the after-tax cost of debt is used in the weighted average cost of capital and not the pre-tax cost of debt.  The cost of equity is usually much higher and can be estimated through the Capital Asset Pricing Model (CAPM).  If a firm is very successful, the stockholders don’t have to share the profits with debtholders since the return on debt is not a variable. 

There are some problems with debt, though.  As a company uses more debt in its capital structure, it increases the company’s risk.  This increases the costs of equity and debt.  If a company has financial problems and can’t cover its interest charges, the firm may have to go bankrupt if it can’t obtain additional financing. 

Firms that have quite variable earnings and operating cash flows are better off having limited debt in their capital structures.  Companies with more stable earnings and operating cash flows can utilize more debt in their capital structures. 

Business risk is probably the most important factor that drives capital structure decisions.  Business risk is the riskiness of a company’s operations if it doesn’t utilize debt.  Financial risk is the increased shareholders’ risk from the use of debt in the capital structure.  There’s no set optimal capital structure for all firms. 

An investor’s total return consists of the capital gains yield and the dividend yield.  Not all companies pay dividends; however, for those that do, it is an important component of an investor’s return, particularly for those seeking income.  Individuals who are retired are usually the clientele most interested in dividends.  If a stock’s price didn’t change all year, yet the company paid a healthy dividend yield, the investor would still earn a positive total return. 

Successful companies typically accumulate a large amount of cash on their balance sheet.  If the company has funded all the positive NPV projects that it wants to, it can look to paying a dividend or buying back stock.  If it currently already pays a dividend, it can look to increase the dividend. 

A company that increases its dividend or institutes a dividend provides a signal to the marketplace that it anticipates higher future cash flows at the firm since once a company increases or starts a dividend it rarely reduces or eliminates the dividend.  On the other hand, a company that decreases its dividend or eliminates a dividend provides a signal to the marketplace that it anticipates lower future cash flows at the firm. 

Optional Resources

Bookboon.com. (2008). Corporate Finance. Retrieved from http://bookboon.com/en/economics-and-finance-ebooks

Welch, Ivo. (2014). Corporate Finance (3^rd Ed.). Chpts 16 and 19. Retrieved from http://book.ivo-welch.info/ed3/toc.html