Chapter 18 Summary - Chapter 18: Dividends & Dividend...

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Dividends come in many forms. The basic types of cash dividends are: 1. Regular Cash Dividends 2. Extra Dividends – the extra means that management is indicating not to expect it to be repeated in the future. 3. Special Dividends – The dividend is a truly unusual or onetime event. 4. Liquidating Dividends – Some or all of the business has been sold off or liquidated and you are receiving the proceeds. In general, we expect that the value of a share of stock will go down by about the dividend amount when the stock goes ex-dividend. If a firm is all equity, the value of the firm is equal to its market capitalization. No matter what pattern of dividend payout the firm chooses, the value of the stock will always be the same; dividend policy makes no difference even if you have to raise money now by issuing stocks and bonds to payout a larger dividend. The reason is simple: Any increase in a dividend at some point in time is exactly offset by a decrease somewhere else; so the net effect, once we account for time value is zero. Meaning if you take out more money today, then you will not have as much money in the future. Example: Suppose that an investor prefers dividends per share of $100 dollar on dates 1 and 2. If the company announced they are going to pay dividends of $110 and $89. This investor can sell a share of stock which is $10 and it will turn into $11 w/ 10% interest. Effectively resulting in $100 and $100 dividend at dates 1 and 2 like before. For individual shareholders, effective tax rates on dividend income are higher than the tax rates on capital gains. Dividends are taxes like ordinary income. Since taxes on capital gains are not taxed up until they are sold it makes it much cheaper than dividends because of the present value of the capital gains tax. Capital Gains tax is DEFERRED which means that you can invest and pay for it, making it significantly cheaper. When deciding to pay out dividends, it depends on whether the personal tax rate is more than the corporate tax rate. If the personal tax rate is lower than a dividend paid out will be taxed less and more can be invested and vice versa. How do floatation cost favor a low payout?
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Chapter 18 Summary - Chapter 18: Dividends & Dividend...

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