5283answers14.apr053 - 1 End of Chapter 14 Questions,...

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End of Chapter 14 Questions, Problems and Solutions CORPORATE FINANCE Professor Megginson April 5, 2003 Questions [See problems in book] *** *** *** *** *** *** *** *** *** *** *** *** *** *** *** *** *** *** *** Answers to End of Chapter 14 Questions 14.1. Dividend policy and capital structure policy are related. If a firm chooses to pay a high dividend from its earnings, then it will have less in retained earnings to reinvest in the company’s projects. If a company has more projects than it can fund from its retained earnings, then it must go to the external markets – debt or new equity financing. Dividends are a use of funds and the greater that use, the more in other sources that the company will need to find. 14.2. All shareholders who own stock on the record date are entitled to receive the dividend declared. Purchasers of a stock that is ex dividend do not receive the dividend. The payment date is generally a few weeks after the record date, and is the day the firm mails the dividend checks. A stock’s price drops when the stock is ex dividend. This is because cash in the amount of the dividend is about to leave the firm. The firm’s assets have been reduced, and the share price should drop accordingly. The actual drop is less than the amount of the dividend, perhaps because of a personal tax effect. 14.3. A low dividend policy is justified to minimize shareholders’ personal taxes. Dividends are taxed at shareholders marginal tax rate, while capital gains first are only taxed when realized, and second, have a lower tax rate than the highest marginal personal tax rate. A high dividend policy is justified if a firm does not have any good investment uses for its cash. It is better to return money to the shareholders rather than invest in negative net present value projects, such as holding cash. A high dividend policy could hypothetically make sense in a tax system with higher rates on capital gains than on dividends. Similarly, if a firm’s shareholders are exempt from taxation, then the rationale for paying low dividends would be reduced. 14.4. Capital markets have a preference for regular dividends because of the signal that they send – that the firm is sound financially, and able to make regular cash payments. It tends to demonstrate that the firm has stable enough cash flows to be able to pay a regular cash dividend. Paying a regular cash dividend may attract certain types of investors. For example, some institutions are not allowed to purchase shares of stock in companies that do not pay regular cash dividends. 14.5. The three types of dividend policies are a constant payout ratio, constant nominal payment policy and low regular and extra dividend policy. In a constant payout ratio policy (rarely seen in practice), the firm chooses a certain percentage of its earnings and pays out that amount as a regular dividend.
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This note was uploaded on 02/23/2009 for the course BUSI 233 taught by Professor Harold during the Spring '07 term at Howard County Community College.

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5283answers14.apr053 - 1 End of Chapter 14 Questions,...

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