Historical Prices on Yahoo Finance

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When I download the historical prices for any company on Y! finance, I get two columns: Closing Price and Adjusted Closing Price.
It says that the adjusted closing price takes into effect the any dividends or stock splits. I understand the stock splits part, but does anyone know how they calculate the adjusted price based on dividends?
How exactly do they calculate the adjusted close price?
Thanks,
 
Say, IBM trades at closes at $100 and issues $1 quarterly dividend/per share. Adjusted Closing price is $101.
 
http://help.yahoo.com/l/us/yahoo/finance/quotes/quote-12.html
Adjusted Close provides the closing price for the requested day, week, or month, adjusted for all applicable splits and dividend distributions. Data is adjusted using appropriate split and dividend multipliers, adhering to Center for Research in Security Prices (CRSP) standards. Split multipliers are determined by the split ratio. For instance, in a 2 for 1 split, the pre-split data is multiplied by 0.5. Dividend multipliers are calculated based on dividend as a percentage of price, primarily to avoid negative historical pricing. For example, when a $0.08 cash dividend is distributed on Feb 19 (ex-date), and the Feb 18 closing price was 24.96, the pre-dividend data is multiplied by (1-0.08/24.96) = 0.9968. Below is a detailed example of adjusted close calculations.
Example: Adjusted Close Calculations
2/13/03 Close = 46.99
2/14/03 Close = 48.30
2/18/03 Split = 2:1
2/18/03 Close = 24.96
2/19/03 Cash Dividend = 0.08 (ex-date)
2/19/03 Close = 24.53
Split Multiplier = 0.5
Dividend Multiplier = 1 – (0.08/24.96) = 0.9968
2/13/03 Adj. Close = 0.5 * 0.9968 * 46.99 = 23.42
2/14/03 Adj. Close = 0.5 * 0.9968 * 48.30 = 24.07
2/18/03 Adj. Close = 0.9968 * 24.96 = 24.88
2/19/03 Adj. Close = 24.53
 
Sorry, the closing price would be $99, but the adjusted is $100.
 
The one you quoted from Yahoo is a more complex example which has more data than the example Trogdor gave. If IBM closes today at $100, and pays dividends at end of day, then tomorrow’s price actual reported close would be $99 if the stock’s demand/supply does not change. The stock will drop by $1 in an intrinsic way. To adjust for that, the $1 is added back, so it would be $100.
However, previous days will need to be adjusted by the propotion you quoted from Yahoo.
 
The adjusted price, which is in the far right-hand column, would be $99, in your case above. If you look at any stock, the adjusted price is always lower than closing price…
 
Here is one real example:
Date…………..Close„„„„,Adj Close*
25-Sep-08…… 11.63 „„„„, 11.08
26-Sep-08…… $ 0.25 Dividend
26-Sep-08…… 11.31„„„„, 11.01
1. On the 26th, the stock closed at $11.31, which gets adjusted to $11.31 + $0.25 = $11.56
2. So, the actual change at the end of the 26th is $11.63 - $11.56 = -$0.07
3. That $0.07 is subtracted from the previous adjusted price yielding $11.01.
 
Understand that the goal of the adjustment is to make the price sequence reflect total returns (necessarily assuming reinvested dividends).
OK, so, IBM Closes yesterday at $100.
Today, IBM Closes at $99, plus it gives out a $1 dividend.
Total return ( $100 yesterday => $99 + $1 = $100 today ) = 0% total return.
—
To make the prices reflect total return, we then need to restate all previous prices such that yesterday’s price to today’s price = 0% return. In other words:
[(Today Close) / (Yesterday Close)*(Mystery Factor)] - 1 = 0%
Because I set it up so that the daily Total Return = 0, the mystery factor is easy: 0.99
Therefore today’s “adjusted” close price is still today’s close price; however all previous prices are multiplied by 0.99.
To compute the factor more generally, just use a little algebra:
(Today Close + Dividend) / (Yesterday Close) = T.R. = (Today Close) / (Yest Close)*Factor
(T.R. is an abbreviation for “total return”)
now rearrange:
Factor = (Today Close) / (Today Close + Dividend)
—
Some people might be tempted to say, “no, you need to add the dividend to today’s price and just adjust today’s price.” But that won’t work, because if you do that, you won’t be able to use tomorrow’s close price to compute the total return from today to tomorrow. So you adjust all prices from yesterday backwards.
 
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