Dividend Policy Flashcards
What are the two different types of finance and give examples of their sources.
External Finance: Finance generated by debt or equity
Internal Finance: Finance generated within the company not required to meet operating costs
What is retained earnings ?
Retained earnings is surplus internal finance
What are some advantages of using retained earnings as a source of finance ?
1) Flexibility
2) No dilution of control
3) No strain on operation 4) No interest costs
What are some disadvantages to retained earnings
1) Lack of Finance required
2) Shareholder Not Happy
3) Opportunity Cost
What is a dividend decision ?
The decision of how much of a companies profit should be paid out to shareholders
What is an investment decision ?
When a company is in a growth phase and shareholders expect the dividend to be low/zero
When will shareholders not mind a dividend being low/zero
When the share price of the company is continuing to rise
What is a financing decision ?
If a company can borrow money finance its investments they could still pay a dividend
What is the constraint to a financing decision ?
The company must have realised accumulated profits in order for it to be legal
What is residual theory ?
In residual theory the company focuses of investing the profits made towards projects which will increase the companies profitability then paying out shareholders with the residual.
Explain Modigliani and Millers dividend irrelevancy theory
M&M’s theory suggests that in a perfect capital market shareholders are indifferent to receiving dividends vs capital gains. Shareholders can adjust their share position withtin the firm if required to receive their desired income stream and dividend policy doesn’t effect the value of a firm
What are some problems with M&M’s dividend irrelevancy theory ?
Taxes: The theory assumes there are no taxes. In reality taxes will effect the shareholders desired income stream
Transaction Costs: When selling shares its common that their are transaction costs
Information: Shareholders don’t always have the necessary information to make decisions.
Time value of money: A dividend now is worth more the uncertain capital gain in the future.
What happens in the real world with dividend policy ?
Signalling: Investors use signalling as a means to understand more about a companies future plans
Tax Preferences: Changes in dividend policy may upset investors tax planning
Clientele Preference: Investors may invest in a company solely based on their dividend policy. If the managers change this policy the investor may stop investing.
Cash Preference: Some investors may prefer to have cash not rather than an increase in future years.
What are other factors that may effect a companies dividend policy ?
Insufficient funds, poor cashflow, law, attracting shareholders, Life cycle issues.
