Equity sources/dividend policy

Question 1

Dividend irrelevance theory : theory + assumptions

Answer 1

= the pattern of dividends over time is irrelevant in determining shareholder wealth as long as a Co always invests in pos NPV projects. If it cannot invest out of retained earnings: assume it will raise funds.
• If dividends lower than desired: sell shares for extra income, replicate an increased dividend – ‘manufactured dividend’
• If higher than desired: buy more shares

Question 2

Arguments against dividend irrelevance theory

Answer 2

• Clientele theory – SHs invest dur to the dividend policy
• Uncertainty – cash now is more certain than possible future returns
• Signalling – markets see dividend reductions as bad news – may lead to drop in SP
• Agency problem – SHs may be nervous that directors act in their own interest tf prefer the cash now
• Taxation – dividends and capital gains (selling shares) are taxed differently
• Cash availability – dividends can only be paid if a company has sufficient cash

Question 3

Listed companies - common dividend policy

Answer 3

Constant dividend with some growth (as opposed to X% from profits) - not the latter, as dividends will rise/fall with profits and this may cause some signalling issues

Question 4

Share repurchase

Answer 4

Co repurchasing issued shares (as an alternative to dividend payout) - reduces equity, increases gearing

Returns £ to SHs without disrupting pattern of dividends

Question 5

Special dividend

Answer 5

A one-off dividend above normal sustainable levels

Question 6

Stock/scrip dividend

Answer 6

Free shares in lieu of cash dividends

Helps Co avoid liquidity problems + allows SHs to swap cash now (income tax) for capital gain later