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ICSE Prelims 2019 : Mathematics (St. Teresas Academy, ModiNagar)

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Vedant Tyagi
St. Teresa's Academy, ModiNagar

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ros69749_ch18.qxd 6/10/02 10:42 AM Page 630 PART SIX Cost of Capital and Long-Term Financial Policy 630 SUMMARY AND CONCLUSIONS 18.9 In this chapter, we first discussed the types of dividends and how they are paid. We then defined dividend policy and examined whether or not dividend policy matters. Next, we illustrated how a firm might establish a dividend policy and described an important alternative to cash dividends, a share repurchase. In covering these subjects, we saw that: 1. Dividend policy is irrelevant when there are no taxes or other imperfections because shareholders can effectively undo the firm s dividend strategy. Shareholders who receive dividends greater than desired can reinvest the excess. Conversely, shareholders who receive dividends smaller than desired can sell off extra shares of stock. 2. Individual shareholder income taxes and new issue flotation costs are real-world considerations that favor a low-dividend payout. With taxes and new issue costs, the firm should pay out dividends only after all positive NPV projects have been fully financed. 3. There are groups in the economy that may favor a high payout. These include many large institutions such as pension plans. Recognizing that some groups prefer a high payout and some prefer a low payout, the clientele effect argument supports the idea that dividend policy responds to the needs of stockholders. For example, if 40 percent of the stockholders prefer low dividends and 60 percent of the stockholders prefer high dividends, approximately 40 percent of companies will have a lowdividend payout, and 60 percent will have a high payout. This sharply reduces the impact of any individual firm s dividend policy on its market price. 4. A firm wishing to pursue a strict residual dividend payout will have an unstable dividend. Dividend stability is usually viewed as highly desirable. We therefore discussed a compromise strategy that provides for a stable dividend and appears to be quite similar to the dividend policies many firms follow in practice. 5. A stock repurchase acts much like a cash dividend, but has a significant tax advantage. Stock repurchases are therefore a very useful part of overall dividend policy. To close out our discussion of dividends, we emphasize one last time the difference between dividends and dividend policy. Dividends are important, because the value of a share of stock is ultimately determined by the dividends that will be paid. What is less clear is whether or not the time pattern of dividends (more now versus more later) matters. This is the dividend policy question, and it is not easy to give a definitive answer to it. C h a p t e r R e v i e w a n d S e l f - Te s t P r o b l e m s 18.1 Residual Dividend Policy The Readata Corporation practices a strict residual dividend policy and maintains a capital structure of 60 percent debt, 40 percent equity. Earnings for the year are $5,000. What is the maximum amount of capital spending possible without selling new equity? Suppose that planned investment outlays for the coming year are $12,000. Will Readata be paying a dividend? If so, how much?

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