Chapter 7 Flashcards
M & M’s dividend irrelevancy theory
Pattern of dividends pay out should be irrelevant
Companies should continue to invest in positive NPV projects
Companies should focus on investment policy rather than dividend policy and if investors required income they could sell shares
M & M’s assumptions
There exists a perfect capital market
No transaction costs
No taxes, or dividends and capital gains are taxed in the same way
Entity’s operating cash flows are the same no matter which dividend policy is adopted
Clientele effect
Companies should follow a consistent dividend policy so as to ensure that they gather to them a clientele of shareholders who like that particular policy
Bird-in-hand argument
Dividend is certain and some investors prefer a certain dividend now, to the promise of future dividends
Key consideration when balancing the theoretical and practical considerations
Clientele effect
Cash needs of the company
Signalling
Legal factors
Debt covenants
Tax implications
Link to investment and financing
Inflation
What are scrip dividends?
Shareholders offered bonus shares free of charge as an alternative to a cash dividend
Reasons for scrip dividend
Company wishes to retain cash in business
Shareholders wish to reinvest dividends in the company
Tax advantages of receiving shares rather than cash
Impact of scrip dividends
Scrip issue has effect of capitalising reserves. Reserves reduce and share capital increases.
Both share price and earnings per share will fall due to grater number of shares in issue
What is share repurchase?
Alternative to paying a dividend is to buy back shares
Used when company has no positive NPV projects to invest in
Advantages of shares repurchase
Choice for investors
Lower future total dividends
No change in share price
Can change control
Removes dividend policy precedent
Disadvantages of share repurchase
Approval needed in general meeting
Difficult to set a fair price for the repurchase
