Chapter 7 Flashcards
M&M dividend, irrelevancy theory
The pattern of dividends overtime is irrelevant into determining shareholder wealth (in a tax-free world)
– a company will always invest in positive and PV projects
– If a company can’t invest in a certain project out of its retained earnings, it will need to race fund from the sources.
– this will potentially lead to existing shareholders receiving proportionately less returns, but the loss will be offset by the dividend they are receiving now
– The ultimate pattern of dividend payments is irrelevant
Factor at least likely to be taken into account setting dividend for the year
The level of other liabilities
Packing order theory
A company should prefer to finance itself first internally through retained earnings
Scrip Dividend
Does not involve the payment of cash
Has no impact on EPS and no certain impacts on price/earnings ratio.
Does not necessarily mean shares become more marketable
Used to keep cash to finance investments
M&M on shareholder wealth growth
= dividends plus growth in share price
Benefits of using retained cash, rather than other sources
Directors can undertake investment projects without shareholders
Avoids possible changes of control that may result from a share issue
NB although avoids transaction costs, there is a cost in the cost of equity
Impact of paying at dividend or making a bonus issue on the wealth of shareholders
Both involve the conversion of wealth that shareholders already have (previous profits) into another form.
Neither would increase their wealth
Share prices/dividend payments/capital gains
In a tax regime where individuals pay more tax on dividends than capital gains.
It is advantageous to the shareholder if funds are used for investment rather than dividends as issued, ultimately mean shareholders, benefiting from enhanced capital gains which taxed the lower rate and dividends.
