Dividend Stock Investing Guide

Top Dividend Stocks

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Top Dividend Stocks Summary


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Future dividends should influence todays stock price

However, note that while the current stock price reflects information about all future dividends, all dividends are not equally important. Because of discounting, current dividends influence the current stock price more than dividends in the far future. The discounting works as follows. The current stock price depends on the discounted expected price and dividends next period, P(0) P(1) + D(1) (1 + r). We also know that next period's price equals the discounted value of expected prices and dividends in period 2. Therefore, in influencing today's stock price, current dividends are discounted only once, D(1) (1 + r), but dividends expected in period 2 are discounted twice. That is because we have to discount P(1) when considering its influence on P(0) and because P(1) itself depends on discounted dividends in period 2. Therefore, the influence of period 2 dividends on the current stock price is twice discounted, D(2) (1 + r)2. Because (1 + r)2 is greater than (1 + r), future dividends...

One interpretation of a low dividend yield is that people became more optimistic about longrun economic growth and the

Either of these forces could account for a decline in the dividend yield during the 1990s. We will consider the risk premium issues in more detail shortly. But another explanation is that stock prices were just far ahead of their fundamental value by the end of the 1990s for some reason, share prices had become higher than would be predicted by companies' earnings. In the light of the large falls in stock prices in 2001 and 2002, this now looks more likely.

She didnt know that you took out a homeequity loan

What did you tell her you were going to do with the money I did tell her that I was going to invest it, but I told her that I was going to invest it in a conservative dividend play that would give us a greater return than the rate we had to pay on the home-equity loan. That was my intention. But once I had the money I thought, I'm not going to put this into some boring dividend play to make a few dollars on the spread between the dividend income and my loan rate. When you are at a brokerage firm, there is always something exciting going on. There is always some stock doubling or tripling. You can't avoid the frenzy. I was listening to the stories being pitched all around me. The salesmen could make any story sound great.

Value Investing Shines in a Declining Market

In early 1987 the shares of Telefonos de Mexico, S.A., sold for prices as low as ten cents. The company was not doing badly, and analysts were forecasting for the shares annual earnings of fifteen cents and a book value of approximately seventy-five cents in 1988. Investors seemed to focus only on the continual dilution of the stock, stemming from quarterly 6.25 percent stock dividends and from the issuance of shares to new telephone subscribers, ostensibly to fund the required capital outlays to install their phones. The market ignored virtually every criterion of value, pricing the shares at extremely low multiples of earnings and cash flow while completely disregarding book value.

The Decision Process Of The Investor In Analysing And Selecting Stocks

Once the investment manager has performed economy, market and industry analysis, he has to shift his emphasis on to company analysis. Security analysts focus on a number of factors which are important in analysing a company. These can be divided into two wide categories, qualitative factors and quantitative factors. Qualitative factors focus mainly on the managerial capacity of the company and its future prospects, which are fundamental to its success. Quantitative factors focus mainly on past and present income statements and the balance sheets of a company and include variables such as earnings, price-to-earnings multiples, dividend yields, capital structure, book-to-market ratios, size etc.

The Choice of a Discount Rate

The only cash flows that investors typically receive from a stock are dividends. The dividend-discount method of valuation, which calculates the present value of a projected stream of future dividend payments, is not a useful tool for valuing equities for most stocks, dividends constitute only a small fraction of total corporate cash flow and must be projected at least several decades into the future to give a meaningful approximation of business value. Accurately predicting that far ahead is an impossibility.

Why would a company give you more stock than the amount of the dividend

Is it common for companies to offer this type of dividend reinvestment It is popular among companies with high dividends who don't want to cut their dividends but need to preserve capital. For example, it was particularly prevalent among the banks in the early 1990s when they were trying to increase their equity.

Application Should Foreign Exchange Rates Follow a Random Walk

9The first type of test, using only stock market data, is referred to as a test of weak-form efficiency, because the information that can be used to predict stock prices is restricted to past price data. The second type of test is referred to as a test of semistrong-form efficiency, because the information set is expanded to include all publicly available information, not just past stock prices. A third type of test is called a test of strong-form efficiency, because the information set includes insider information, known only to the managers (directors) of the corporation, as when they plan to declare a high dividend. Strong-form tests do sometimes indicate that insider information can be used to predict changes in stock prices. This finding does not contradict the efficient market hypothesis, because the information is not available to the market and hence cannot be reflected in market prices. In fact, there are strict laws against using insider information to trade in financial...

Liquidity and asset pricing

In this section we discuss the model of Amihud and Mendelson (1986), which is a generalization of the Gordon dividend growth model for asset valuation, where the value of a share with perpetual dividends d (and no growth of dividends) is P d r, where r is the risk-adjusted discount rate. The Amihud-Mendelson model has the following parameters a perpetual per-period dividend d the required risk-adjusted return r the relative bid-ask spread S and the expected trading frequency x. The

Investing in Spinoffs

Opportunities can sometimes arise not in the spinoff but in the parent-company shares. As an example, at the end of 1988 Burlington Northern, Inc. (BNI), which owned a major railroad and a natural resources company, spun off its investment in Burlington Resources, Inc. (BR), to shareholders. A number of unusual market forces were at work at the time that created an investment opportunity in the ongoing parent company, BNI. What happened is this many investors held BNI primarily because of its ownership of BR, which represented about two-thirds of the dollar value of the combined company. A number of these investors apparently sold BNI before the spinoff was completed and bought the newly formed BR, causing BNI to decline in price relative to BR. This created an opportunity for other investors to buy BNI stock pre-spinoff and sell BR stock short in order to lock in a cost of approximately 19 per share for the newly separated railroad business. Since the railroad was expected by...

Some Important Identities

Profits grow over time. If that dividend should increase with profits, say at a rate of 5 percent annually, then, by the 30th year, your annual dividend payment will be over 800, or one-third more than the bond is yielding. The price of the stock almost certainly will have risen as well.

S70 1860 1890 1900 1910 1910

Fig. 2, Chapter 10, on Business Cycles, shows the rhythmic movement that occurs in various business and financial conditions. Taking the curve of commodity prices as the central fact, it is seen that its peak has been preceded in time successively by peaks of bank reserves, loans, and clearings, and by stock prices (which always speculatively anticipate higher dividends) and is soon followed by declining dividends, by the peak of discount rates, and by failures then bank reserves gradually being built up, the cycle is repeated. This diagram, hitherto unpublished, was prepared by Professor G. R. Davies, University of North Dakota, to whose courtesy we are indebted for permission to use it here. The data are plotted so as to show the variations above and below the averages, eliminating the absolute growth due to increasing population, business, etc. Fig. 2, Chapter 10, on Business Cycles, shows the rhythmic movement that occurs in various business and financial conditions. Taking the...

Mountain Equipment Coop

MEC is a retail consumer cooperative, meaning that it purchases selected merchandise and makes it available to its membership at the least possible cost. MEC operates as a not-for-profit enterprise, dispersing earnings by providing retail space for members to shop, donating to selected wilderness and community oriented causes and occasionally paying dividends to members. If there is a surplus left over after all costs and community investments are made at the end of the operating year, it is a tiny cushion to ensure long-term financial sustainability.23

The Circulation Of Brokerage Deposits

The brokerage deposit may be primary or derivative. From the point of view of the individual broker the customers' balances come into being, firstly, through deposits of cash (in the form of bank cheques) by the customers who have given (or intend to give) orders to buy, or on the customers' account for dividends received and, secondly, through a sale of paid-up securities for the customers' account. For all brokers together, however, customers' balances come into being, firstly, through deposits of cash (as before) and, secondly, through loans to customers.

Security constraint and sources of finance

Debt borrowing requires the future repayment of the amount borrowed together with annual interest payments. These payments are a prior charge on the firm's profits and must be made before paying dividends to shareholders. Therefore, debt payments reduce the amount of profit available for distribution and will lead to a fall in the share price and in the market value of the firm if they reduce expected future dividend payments. The other source of new finance is the issuing of new equity. The cost of equity is the future dividends new shareholders will receive along with the existing shareholders. To ensure that the new equity does not dilute the profits due to existing shareholders and, therefore, depress the share price, managers must ensure that the investment will be profitable enough to maintain or pay an increased dividend to all shareholders in line with expectations. Otherwise, shareholders may become discontented, sell their shares and the market value of the firm will be...

Possible alternatives and policy solutions

In addition, the money is being spent outside the country, including Mr Abramovich's 300 million acquisition of Chelsea soccer club in Britain, buying a 90 million luxury yacht allegedly registered in the Bahamas and ordering a new Boeing 767 for his personal use. Large dividends in excess of 10 million should be taxed at a minimum of 50 per cent and, when transferred abroad, at an even higher rate of, say, 75 per cent. This would be a fair means of returning at least some of the mineral rent appropriated by the oligarchs due to lax taxation in former years.

The Governments Bias in Favor of the Cooperatives

Nonetheless the governments behave as if private business were an objectionable thing and as if the salvation of mankind were to depend on the cooperatives. They openly and avowedly discriminate against private business in subjecting its surpluses to a burdensome taxation from which a surplus made by a cooperative is exempt. They discriminate especially against the corporations in taxing corporate incomes both on the corporation and on the shareholders who receive dividends. Confiscatory rates of personal-income taxation curtail the amount of venture capital available for the conduct of private business while the cooperatives are allowed to accumulate capital either without being taxed at all or without being taxed to the extent private business is taxed.

Sequence of Project Valuation

Fifth, expected cash flows are converted to a present value to obtain a clear estimate of the investment project's value to the firm. This is equivalent to finding the present value of expected future dividends or interest plus principal payments. Finally, the present value of expected cash inflows is compared with the required outlay, or cost, of the project. If the present value of cash flows derived from a project exceeds the cost of the investment, the project should be accepted. Otherwise, the project should be rejected.

Conceptual Questions

(19.4) A German investor places some funds with an emerging market stock market fund and intends to leave it there for 5 years and have all dividends paid into a Munich bank account. How will this affect the German current and capital account in each of the next five years

Component Cost of Equity Financing

The risk-free return is typically estimated by the interest rate on short-term U.S. government securities. On a daily basis, these rates of return can be obtained from The Wall Street Journal and other sources. Various methods can be used to estimate RP for different securities. Because dividends paid to stockholders are not deductible for income tax purposes, dividend payments must be made with after-tax dollars. There is no tax adjustment for the component cost of equity capital. Dividend Yield + Capital Gains _ Expected Dividend Expected because of its own unique situation or because of general economic conditions, investors cannot project historical growth rate into the future. Security analyst estimates of g must then be relied on. These earnings forecasts are regularly found in Barron's, The Value Line Investment Survey, and other sources and offer a useful proxy for the growth expectations of investors in general. When security analyst growth projections are combined with the...

Share prices and yields

Share prices reflect the discounted value of future dividend payments, with a premium thrown in to reflect the risks. Future dividends depend on company profits, which in turn reflect the quality of management and the state of the economy. For the stockmarket as a whole, variations in management quality average out, leaving perceptions about the state of the economy as a key factor in determining overall share prices.

Figure A2 Heat pump and baseboard system differential life cycle costs

The second broad source of funding is equity financing. Under equity financing the lender acquires an ownership (or equity) position within the borrower's organization. As a result of this ownership position, the lender has the right to participate in the financial success of the organization as a whole. The two primary sources of equity financing are stocks and retained earnings. The cost of capital associated with shares of stock is much debated within the financial community. A detailed presentation of the issues and approaches is beyond the scope of this appendix. Additional reference material can be found in Park and Sharp-Bette 1990 . One issue over which there is general agreement is that the cost of capital for stocks is higher than the cost of capital for debt financing. This is at least partially attributable to the fact that interest payments are tax deductible while stock dividend payments are not.

The Enron Scandal and the Stock Market

The September 11 terrorist attacks raised the possibility that terrorism against the United States would paralyze the country. These fears led to a downward revision of the growth prospects for U.S. companies, thus lowering the dividend growth rate (g) in the Gordon model. The resulting rise in the denominator in Equation 5 would lead to a decline in P0 and hence a decline in stock prices. Subsequently, the U.S. successes against the Taliban in Afghanistan and the absence of further terrorist attacks reduced market fears and uncertainty, causing g to recover and ke to fall. The denominator in Equation 5 then fell, leading to a recovery in P0 and a rebound in the stock market in October and November. However, by the beginning of 2002, the Enron scandal and disclosures that many companies had overstated their earnings caused many investors to doubt the formerly rosy forecast of earnings and dividend growth

The Nature Of Qualitative Response Models

One can think of several other examples where the regressand is qualitative in nature. Thus, a family either owns a house or it does not, it has disability insurance or it does not, both husband and wife are in the labor force or only one spouse is. Similarly, a certain drug is effective in curing an illness or it is not. A firm decides to declare a stock dividend or not, a senator decides to vote for a tax cut or not, a U.S. President decides to veto a bill or accept it, etc.

LP Pension Funding Model

To illustrate the type of retirement income funding model that a company might make available to employees, consider the following scenario. Suppose that an individual employee has accumulated a pension portfolio worth 250,000 and hopes to receive initial post-retirement income of 500 per month, or 6,000 per year. To provide a total return from current income (yield) plus growth (capital gains) of at least 7 , a minimum of 25 of the portfolio should be invested in common stocks. To limit risk, stocks should total no more than 50 of the overall portfolio, and a minimum of 5 should be invested in long-term taxable bonds, 5 in medium-term tax-exempt bonds, and 5 in a short-term money-market mutual fund. Moreover, not more than 75 of the overall portfolio should be invested in stocks plus long-term taxable bonds, and at least 30,000 should be available in money markets plus medium-term tax-exempt bonds to provide sufficient liquidity to fund emergencies. Assume that common stocks have a...

The Nature Of Heteroscedasticity

Airplane Drawing Step Step

As incomes grow, people have more discretionary income2 and hence more scope for choice about the disposition of their income. Hence, a2 is likely to increase with income. Thus in the regression of savings on income one is likely to find a2 increasing with income (as in Figure 11.2) because people have more choices about their savings behavior. Similarly, companies with larger profits are generally expected to show greater variability in their dividend policies than companies with lower profits. Also, growth-oriented companies are likely to show more variability in their dividend payout ratio than established companies.

Tradeoff Between Safety and Returns to Equity Holders We now see that bank capital

To lower the amount of capital relative to assets and raise the equity multiplier, you can do any of three things (1) You can reduce the amount of bank capital by buying back some of the bank's stock. (2) You can reduce the bank's capital by paying out higher dividends to its stockholders, thereby reducing the bank's retained earnings. (3) You can keep bank capital constant but increase the bank's assets by acquiring new funds say, by issuing CDs and then seeking out loan business or purchasing more securities with these new funds. Because you think that it would enhance your position with the

The 1997 Financial Crisis And Its Impact On Financial Reforms

During 1990-95, local commercial banks managed to accumulate their first-tier capital internally through the marked increase of retained earnings. To accomplish this, banks decreased their dividend payout to net profit ratio from 47 per cent in 1990 to 35 per cent in 1995. The banks also succeeded in the accumulation of second-tier capital. The increase in Tier 2 capital could be attributed to two main factors. First, Thai commercial banks were able to issue long-term subordinated debt in foreign currency denominations since early 1993, at a time when the Thai banking sector was very healthy. Second, the rapid expansion of branch networks of Thai banks in the past ten years had yielded a large number of new premises.

Are Stock Prices Forecastable

Shiller wanted to compare the volatility of stock prices observed in practice with the volatility of share prices if they are based on rational forecasts of future dividends. However, we cannot recreate now what rational forecasts of future dividends were in 1870. Therefore, Shiller focused instead on the volatility of share prices assuming that the investor had perfect foresight about future dividends. If you had known in 1870 what dividends U.S. companies would pay over the next 100 years, then using the logic of Figure 17.7, you could work out what the price of equities should have been over this period on the basis of this perfect foresight. (Of course, this depends on choosing a discount factor r.) Shiller argued that the actual path of dividends that companies paid over that 100-year period should have been more volatile than the path that it was rational to expect in 1870. In other words, if actual share prices are more volatile than Shiller's perfect foresight share price,...

Policy 1 Taxes And Saving

Another of the Ten Principles of Economics is that people respond to incentives. Many economists have used this principle to suggest that the low saving rate in the United States is at least partly attributable to tax laws that discourage saving. The U.S. federal government, as well as many state governments, collects revenue by taxing income, including interest and dividend income. To see the effects of this policy, consider a 25-year-old individual who saves 1,000 and buys a 30-year bond that pays an interest rate of 9 percent. In the absence of taxes, the 1,000 grows to 13,268 when the individual reaches age 55. Yet if that interest is taxed at a rate of, say, 33 percent, then the after-tax interest rate is only 6 percent. In this case, the 1,000 grows to only 5,743 after 30 years. The tax on interest income substantially reduces the future payoff from current saving and, as a result, reduces the incentive for people to save.

Methods For Including Cost Of Capital In Economic Analyses

The cost of new capital obtained from bonds, loans, or preferred stock can be determined directly from the stated interest or dividend rate, adjusted for income taxes. However, the cost of new capital obtained from the issue of common stock is not so obvious, and some basis must be set for determining this cost. Probably the fairest basis is to consider the viewpoint of existing holders of common stock. If new common stock is issued, its percent return should be at least as much as that obtained from the old common stock otherwise, the existing stockholders would receive a lower return after the issue of the new stock. Therefore, from the viewpoint of the existing stockholders, the cost of new common stock is the present rate of common-stock earnings.

Risk Equity Prices and Excess Return

Do we mean by risk here, and how might we measure it The answer to these questions matters a lot, because movements in the risk premium can dramatically affect stock prices. If people come to think of equities as much more risky, they might require that, on average, they yield 10 more than government bonds, rather than, say, 5 more. Discounting future dividends at a rate that is higher by 5 could easily generate 40 or 50 falls in the price of equities. We can see, in principle, why this is so if we look again at Figure 17.7. Anything that causes the required rate of return to increase will decrease share prices unless there are compensating shifts in future dividends. Therefore, increases in risk premiums will lead to sharp falls in share prices even if investor forecasts of future dividends do not change. The simple dividend discount model for stock prices, combined with an assumption of anticipated steady dividend growth, generates a link between stock prices, the latest dividend...

Accumulated Retained Earnings

To obtain the value of the retained earnings, the company starts at the beginning of the year with the previous year's balance. To that figure the net profit after taxes for the year is added. The dividends paid to the preferred and common stockholders are subtracted. The result is the retained earnings at the end of the year.

Financing the Corporate Venture

In the period after World War II, growth was one of the management goals. For companies to maintain a regular dividend policy, external funding for ventures had to be sought. In very recent times, with the mergers, acquisitions, joint ventures, and alliances, and interest in megadollar projects, external sources were the only option for large-scale projects. Cash generated from internal sources alone could not begin to fund the capital-intensive projects.

Esco Electronics An Exercise in Securities Valuation

Conventional Valuation Yardsticks Earnings, Book Value, and Dividend Yield We are near the end of a chapter on business valuation, and there has been virtually no mention of earnings, book value, or dividend yield. Both earnings and book value have a place in securities analysis but must be used with caution and as part of a more comprehensive valuation effort. Dividend Yield Why is my discussion of dividend yield so short Although at one time a measure of a business's prosperity, it has become a relic stocks should simply not be bought on the basis of their dividend yield. Too often struggling companies sport high dividend yields, not because the dividends have been increased, but because the share prices have fallen. Fearing that the stock price will drop further if the dividend is cut, managements maintain the payout, weakening the company even more. Investors buying such stocks for their ostensibly high yields may not be receiving good value. On the contrary, they may be the...


A limited partnership is, by its very nature, a pass-through entity that owes no taxes on the taxable income that it produces. This is true even if the hedge fund does not distribute any of its taxable income. And, generally speaking, hedge funds do not make regular distributions to their investors. Interest income, dividend income, and realized gains are retained within the fund. But the hedge fund investor owes taxes on her share of the taxable income even if that amount is not literally distributed. If a hedge fund investor wants access to her invested capital, she must redeem some or all of her ownership interest in the fund.

Chapter Summary

A hybrid type of stock that pays dividends at a specified rate (like a bond), and has preference over common stock in the payment of dividends and liquidation of assets. However, if the firm is financially strained, it can avoid paying the preferred dividend as it would the common stock dividends. Preferred stock doesn't ordinarily carry voting rights.

The Right Price

If a stock price is the best possible estimate of the risk-adjusted value of future dividends and resale values, then individual investors can do no better than to buy a portfolio of stocks and other asset prices that matches their risk preferences.7 There is no need for these investors to make their own estimates of the value of individual assets. In this sense, the price is right for them.

Doable O2

Dogs of the Dow (G1) An approach to investment based on using dividend data. At the beginning of the year, US stocks listed by Dow are ranked by dividend yield from the highest to the lowest and then an equal amount is invested in each of the top ten stocks. The following year the procedure is repeated and the stocks whose rank has fallen below the top ten are sold.

Equity G1

3 The portion of a company's capital which does not earn a fixed rate of interest. Equity holders usually receive dividends varying with the profitability of the company corporation and its profit distribution policy. The issue of equity shares enables a company to expand its capital and to spread business risk.

Return On Investment

Delayed rewards for costs incurred earlier are a return on investment, whether these rewards take the form of dividends paid on corporate stock or increases in incomes resulting from having gone to college or medical school. One of the largest investments in many people's lives consists of the time and energy expended over a period of years in raising their children. At one time, the return on that investment included having the children take care of the parents in old age, but today the return on this investment often consists only of the parents' satisfaction in seeing their chil

Cost of equity RE

If the firm raises funds through the issue of new equity capital, then the purchaser of the equity will expect to receive dividends equivalent to the risk-free rate of interest plus a risk premium. The current price of equity will reflect the discounted value of future dividends. An alternative explanation for the cost of equity is the dividend evaluation model. Assuming the investor has full information, the value of a share is equal to the discounted value of future expected future dividends, or

Migration F2 J1

Miller, Merton, 1923-2000 (B3) Educated at Harvard and Johns Hopkins universities and professor at the university of chicago from 1981. Along with modigliani, from 1958 he established that in corporate finance a firm's value is determined by its investment decisions, not its dividend policy. His interests broadened to include the regulation of financial services through his directorships of the Chicago Board of Trade and Chicago Mercantile Exchange. in 1990, he shared

Commercial Banking

Modern Islamic banks are prohibited from lending money at interest so they must instead find other ways to charge for their services. One common solution is to become part owners, not creditors, of an enterprise that they finance and so be entitled to a share in any profits. That is, they thus receive dividends on funds invested, not interest on a loan.

Performance Fees

Hedge funds typically charge a fixed asset-based fee plus a performance-based fee. Let's look briefly at how performance fees would work in a hypothetical case. Suppose a hedge fund manager charges 1 percent on the assets under management plus 20 percent of the total return. And suppose the manager's fund is up 20 percent for the calendar year, before any management fees but after brokerage commissions and any other expenses directly related to trading the portfolio. The 20 percent return combines all the elements of total return interest income, interest expense, realized gains and losses, and changes in unrealized appreciation or depreciation. Interest income includes stock dividends, bond interest, interest on cash balances, and interest earned on the proceeds of short sales. Interest expense includes financing charges relate d to leverage and dividends or interest owed on short positions. Importantly, the total return that we are talking about is not just total realized return or...

Asset Returns

People buy and hold assets because of the monetary flows they provide. To compare assets with each other, it helps to think of this monetary flow relative to the asset's price or value. The return on an asset is the total monetary flow it yields as a fraction of its price. For example, a bond worth 1000 today that pays out 100 this year (and every year) has a return of 10 percent.12 If an apartment building was worth 10 million last year, increased in value to 11 million this year, and also provided a net (of expenses) rental income of 0.5 million, it would have yielded a return of 15 percent over the past year. Or if a share of General Motors stock had been worth 80 at the beginning of the year, fell to 72 by the end of the year, and paid a dividend of 4, it would have yielded a return of -5 percent (the dividend yield of 5 percent less the capital loss of 10 percent).

Dairy Indus Jg

The monetary flow that one receives from owning an asset can take the form of an explicit payment, such as the rental income from an apartment building Every month the landlord receives rent checks from the tenants. Another explicit payment is the dividend on shares of common stock Every three months the owner of a share of General Motors stock receives a quarterly dividend payment.

Source Of Capital

New capital may also be obtained from the issue of bonds, preferred stock, or common stock. Interest on bonds and preferred-stock dividends must be paid at fixed rates. A relatively low interest rate is paid on bonds because the bond-holder has first claim on earnings, while higher rates are paid on preferred stock because the holder has a greater chance to lose the entire investment. The holder of common stock accepts all the risks involved in owning a business. The return on common stock, therefore, is not at a fixed rate but varies depending on the success of the company which issued the stock. To compensate for this greater risk, the return on common stock may be much higher than that on bonds or preferred stock. If the annual income-tax rate for a company is 34 percent, every dollar spent for interest on loans or bonds would have a true cost after taxes of only 66 cents. Thus, after income taxes are taken into consideration, a bond issued at an annual interest rate of 6 percent...

Key Terms

AER APR APY Annual Equivalent Rate Annual Percentage Rate Annual Percentage Yield Annual Rate, Compounded Daily Basis Point Bond CD Capital Budgeting Capital Cain Capital Loss Certificate Of Deposit Compound Interest Compounding Cost Of Capital Coupon Coupon Yield Current Yield Discount Factor Discount Rate Discounting Dividend Dividend Yield Effective Annual Rate Fixed Income Future Value Holding Rate Of Return Interest Interest Rate Law Of One Price Loan Maturity Net Present Value Net Present Value Capital Budgeting Rule Net Return Opportunity Cost Opportunity Cost Of Capital Perfect Market Present Value Present Value Formula Rate Of Return Rental Yield Return Time Value Of Money.

Economic Value Added

In periods when the economy is strong and sales are growing, the bottom line still might not show good results. EVA analysis helps companies identify waste and inefficiency in their daily operations and in the use of capital. It also aids in identifying high inventories as well as the need to reduce accounts receivable. In other words, EVA is a tool to improve overall efficiency. In some instances, EVA has demonstrated that debt capital is cheaper than equity capital. It gives management a clearer idea of whether they are increasing or decreasing stockholders' wealth. Stockholders can benefit from EVA analysis if it results in higher dividends and permits stick share repurchases. Further, some companies are tying EVA to salaries and bonuses of upper-level company executives.

Internal Sources

Retained earnings of a company are the difference between the after-tax earnings and the dividends paid to stockholders. If a firm plans no growth, then theoretically all the after-tax earnings could be distributed as dividends to the stockholders. Management would not do this. The company retains a certain part of the profits, and a part is paid to the stockholders as dividends. That part retained may be used for research and development expenditures or for capital projects 1 .


The stockholders who have preferred stock have a preference over the shareholders regarding dividends and or the distribution of assets. Some preferred stock is called cumulative which means that if in any given year the company does not pay dividends, the unpaid dividends accumulate, and when these obligations are paid, the preferred stockholders receive stock dividends before the holders of common stock. Preferred stockholders do not normally have a voice in company affairs or voting rights unless the company fails to pay them dividends. Preferred stock is carried on the company books at a stated par value. On the other hand, there are no limitations on the dividends paid to holders of common stock. If the company's earnings are high, dividends are paid, but if the earnings are low, dividends may not be paid at all. Common stock is valued at stated par value. Accumulated Retained Earnings. This term is sometimes referred to as earned surplus. The accumulated retained...

Cost of equity

Where Dt is the dividend paid by the firm in period t. Since the future value of the share, Vn, is in turn determined by the sum of expected future dividends, equation (11.9) can be rewritten as the sum to infinity of all expected future dividends Just as the CAPM has its problems, so does the DVM also have drawbacks. Its main failing is essentially the same as with the CAPM it looks backwards rather than forwards. While historical data can be used to estimate the average growth rate of dividends over the last ten or twenty years say, such information is not a reliable indicator of future dividend growth rates. Furthermore, current share prices can be highly volatile, and many firms do not pay dividends at all if management believes that the funds can be more profitably reinvested in the firm than returned to shareholders. It can therefore readily be seen that many fast-growing high-tech firms would on this basis have very uncertain estimates of their cost of capital.

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