1 of 24 ©2012 McGraw-Hill Ryerson Limited Learning Objectives 1.Justify management’s decision criteria as to whether internally generated funds should be re-invested or paid out as dividends. (LO1) 2.Describe a dividend payment as a passive or active decision based on investor preference and the informational content of dividends. Calculate dividend payout ratios and dividend yields. (LO2)

2 of 24 ©2012 McGraw-Hill Ryerson Limited Dividends vs. Retained Earnings A company has a choice or decision regarding what to do with its profits: –Pay them out to shareholders as OR –Retain the earnings in the business There is disagreement as to whether investors prefer dividends or reinvestment LO1

3 of 24 ©2012 McGraw-Hill Ryerson Limited Theories of Dividend Policy 1. Irrelevance of Dividend Policy Proposition: under ideal conditions, dividend policy is irrelevant and doesn’t affect share price. Logic: shareholders can create dividends on their own – –homemade dividends. LO1

4 of 24 ©2012 McGraw-Hill Ryerson Limited Figure 18-1 Homemade dividends LO1

5 of 24 ©2012 McGraw-Hill Ryerson Limited Theories of Dividend Policy 2. Relevance of Dividend Policy Proposition: dividend policy is relevant and a positive relationship exists between dividends and share price because a) dividends resolve uncertainty and b) dividends have information content – The corporate is saying it had a good year. As the real world is not perfect, dividend policy seems to be relevant. LO1