TAILIEUCHUNG - Lecture Fundamentals of financial management (13/e) - Chapter 18: Dividend policy

After studying chapter 18, you should be able to: Understand the dividend retention versus distribution dilemma faced by the firm, explain the Modigliani and Miller (M&M) argument that dividends are irrelevant, explain the counterarguments to M&M – that dividends do matter, identify and discuss the factors affecting a firm’s dividend and retention of earnings policy,. | Chapter 18 Dividend Policy © 2001 Prentice-Hall, Inc. Fundamentals of Financial Management, 11/e Created by: Gregory A. Kuhlemeyer, . Carroll College, Waukesha, WI Dividend Policy Passive Versus Active Dividend Policies Factors Influencing Dividend Policy Dividend Stability Stock Dividends and Stock Splits Stock Repurchase Administrative Considerations Dividends as a Passive Residual The firm uses earnings plus the additional financing that the increased equity can support to finance any expected positive-NPV projects. Any unused earnings are paid out in the form of dividends. This describes a passive dividend policy. Can the payment of cash dividends affect shareholder wealth? If so, what dividend-payout ratio will maximize shareholder wealth? Irrelevance of Dividends M&M contend that the effect of dividend payments on shareholder wealth is exactly offset by other means of financing. The dividend plus the “new” stock price after dilution exactly equals the stock price prior to the dividend distribution. A. Current dividends versus retention of earnings Irrelevance of Dividends M&M and the total-value principle ensures that the sum of market value plus current dividends of two firms identical in all respects other than dividend-payout ratios will be the same. Investors can “create” any dividend policy they desire by selling shares when the dividend payout is too low or buying shares when the dividend payout is excessive. B. Conservation of value Relevance of Dividends Uncertainty surrounding future company profitability leads certain investors to prefer the certainty of current dividends. Investors prefer “large” dividends. Investors do not like to manufacture “homemade” dividends, but prefer the company to distribute them directly. A. Preference for dividends Relevance of Dividends Capital gains taxes are deferred until the actual sale of stock. This creates a timing option. Capital gains are preferred to dividends, everything else equal. Thus, high .

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