Finance Topic 5 Flashcards
dividend policy question
decision making process
distribution of profits (SHs as dividends)
portion paid as dividends and portion retained for inv
value of firm influenced by dividend decision? M&M says no
Gordon growth model
firms growth rate is at least partially affected by amount of profit it retains
interaction with investment policy & capital structure
- dividend payment = no longer available for new inv & replacement funding
- paying dividends = reduces ceteris paribus (amount of equity funding in firm) = raise leverage/gearing
9 Impactors on dividend policy (discussion Q)
- amount of reserves distributable to SHS (regulation) - no dividend from permanent capital
- contractual limitations (restrictive loan covenants & service debt in full)
- liquidity
- taxation position of dividend recipients
- clientele theory/effect
- earnings stability/signalling
- agency theory
- nature of firm (‘family firm = personal circumstances of owners)
- capital gains tax position
taxation position of dividend recipients
income tax position (dividend distribution)
capital gains tax position (sell shares = liable to capital gains)
special tax position certain institutional investors
dividend payment to investors = liability to income risk
inv value dividend based on institution or tax rate (dissatisfied = sell = value decreases)
clientele theory/effect
equity inv = aware of manifestation of dividend policy of firms
inv preferences = consider income need/tax position (care about diversification)
firm to invest base don this
no particular dividend policy implied to be intrinsically superior
earnings stability/signalling
info content of dividend
info asymmetry = signalling opp
dividend rate increase = costly if have to be reversed
later reduction in dividend rate = -ve in mkt
agency theory
retain cash = scope for mngment to pursue self interest = invest in +ve NPV in interest of SHs
+ve dividend policy = reduce agency cost
factors favouring high dividend
- retention ( has more risk than cash in hand) - investor worry when company retains cash
- source of current income
- info content/signalling
- brokerage cost
factors generally favouring low payout
- Taxation
- Flotation costs of new equity issues
- Availability of many attractive inv opps
modigliani & miller 1961 assumption regarding dividends (topic 5)
-firm value is unaffected by dividend policy
1. no tax
2. no transaction costs
3. no info asymmetry
-assume all firms are equity financed (simple & avoid capital structure effects)
-start by considering firms which are identical (cash flow/inv outlay/ risk class) -> except dividend payout in current period
M&M dividend policy without growth
world without taxes/transaction costs
value of equity
recursive valuation formula
V on both sides
dividends dont feature (dividend policy is irrelevant to value)
recursive valuation formulae explanation
-irrelevance of current period dividend payout
-terms = invariant between firms, differing solely as regards to dividend lvl
-current value of firm is same for those firms
-absence of M&M assumptions and with availability of external financing
-firm value depends on distribution of future cf provided by inv decisions firm can chose any dividend policy - excess dividend fund inv via new equity
low dividend = use spare cash to buy back shares
M&M linked to divided policy
-certain assumption value of firm not affected by dividend policy (doesnt influence overall firm value)
-argue inv decision and profitability of firm primarily impact value
