Ross et al.: Fundamentals
of Corporate Finance, Sixth
Edition, Alternate EditionVI. Cost of Capital and
Long−Term Financial
Policy- Dividends and Dividend
Policy
© The McGraw−Hill^635
Companies, 2002reflect that fact because of mailing or other delays. Without some modification,
some of the dividend checks will get mailed to the wrong people. This is the reason
for the ex-dividend day convention.
4.Date of payment.The dividend checks are mailed on February 16.More on the Ex-Dividend Date
The ex-dividend date is important and is a common source of confusion. We examine
what happens to the stock when it goes ex, meaning that the ex-dividend date arrives. To
illustrate, suppose we have a stock that sells for $10 per share. The board of directors
declares a dividend of $1 per share, and the record date is set to be Tuesday, June 12.
Based on our previous discussion, we know that the ex date will be two business (not
calendar) days earlier, on Friday, June 8.
If you buy the stock on Thursday, June 7, just as the market closes, you’ll get the $1
dividend because the stock is trading cum dividend. If you wait and buy it just as the
market opens on Friday, you won’t get the $1 dividend. What happens to the value of
the stock overnight?
If you think about it, you will see that the stock is worth about $1 less on Friday
morning, so its price will drop by this amount between close of business on Thursday
and the Friday opening. In general, we expect that the value of a share of stock will go
down by about the dividend amount when the stock goes ex dividend. The key word
here is about.Because dividends are taxed, the actual price drop might be closer to some
measure of the aftertax value of the dividend. Determining this value is complicated be-
cause of the different tax rates and tax rules that apply for different buyers.
The series of events described here is illustrated in Figure 18.2.As a more concrete example, in the first quarter of 2001, McGraw-Hill, which we
feel compelled to note is a very fine company,^1 boosted its dividend by 4.3 percent. In
fact, dividends have been paid by the company since 1937 and have increased without
fail since 1974, growing at a compound rate of 10.9 percent over the following 27-year
period. The dividend record date was February 26, with payment to be made on March- The new quarterly dividend was $.245 a share.
The record date was February 26, a Monday, so the ex date was Thursday, the 22nd.
When the market opened, McGraw-Hill’s stock price dropped by $0.11, or only about
half of the dividend. However, the market was very active that day, so the dividend
608 PART SIX Cost of Capital and Long-Term Financial Policy
date of payment
The date that the
dividend checks are
mailed.
(^1) The reason we feel so compelled is that McGraw-Hill is the publisher of this textbook!
“Ex” Marks the Day
The board of directors of Divided Airlines has declared a dividend of $2.50 per share payable
on Tuesday, May 30, to shareholders of record as of Tuesday, May 9. Cal Icon buys 100 shares
of Divided on Tuesday, May 2, for $150 per share. What is the ex date? Describe the events
that will occur with regard to the cash dividend and the stock price.
The ex date is two business days before the date of record, Tuesday, May 9, so the stock
will go ex on Friday, May 5. Cal buys the stock on Tuesday, May 2, so Cal purchases the stock
cum dividend. In other words, Cal will get $2.50 100 $250 in dividends. The check will
be mailed on Tuesday, May 30. Just before the stock does go ex on Friday, its value will drop
overnight by about $2.50 per share.
EXAMPLE 18.1