Dividends & Share Repurhases

Question 1

MM dividend irrelevance theory

Answer 1

Holds that in a no tax/no fees world, dividend policy is irrelevant since it has no effect on the price of a firm’s stock or its cost of capital, because individual investors can create their own homemade dividend

Question 2

Dividend preference theory

Answer 2

Says investors prefer the certainty of current cash to future capital gains

Question 3

Tax aversion theory

Answer 3

States that investors are tax averse to dividends and would prefer companies instead buy back shares, especially when the tax rate on dividends is higher than the tax rate on capital gains

Question 4

Factors that affect a firm’s dividend payout policy

Answer 4

Investment opportunities
Expected volatility of future earnings
Financial flexibility
Tax considerations
Flotation costs
Contractual and legal restrictions

Question 5

Effective rate under double taxation

Answer 5

= corporate tax rate + (1 - corporate tax rate)*(individual tax rate)

Question 6

Rationales for share repurchases vs dividends

Answer 6

Potential tax advantages
Share price support/signaling
Added flexibility
Offsets dilution from employee stock options
Increases financial leverage by reducing equity in the balance sheet

Question 7

FCFE coverage ratio

Answer 7

= FCFE / (dividends + share repurchases)