Finance Topic 5 Flashcards
(17 cards)
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
M&M theory assumptions linked to divided policy
- perfect capital markets
- investors preferences
- no info asymmetry
- investment policy
why managers/directors spend time/effort deciding firm dividend (discussion Q)
- SH expectations
- Investor relations
- capital market signalling
- cash flow planning (financial health)
- capital structure considerations
- legal/regulatory compliance
- strategic considerations (goals)
