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Unformatted text preview: CHAPTER 13 Dividend Policy and Internal Financing CHAPTER ORIENTATION In determining the firms dividend policy, two issues are important: the dividend payout ratio and the stability of the dividend payment over time. In this regard, the financial manager should consider the investment opportunities available to the firm and any preference that the companys investors have for dividend income or capital gains. Also, stock dividends, stock splits, or stock repurchases can be used to supplement or replace cash dividends. CHAPTER OUTLINE I. The tradeoffs in setting a firms dividend policy A. If a company pays a large dividend, it will thereby: 1. Have a low retention of profits within the firm. 2. Need to rely heavily on a new common stock issue for equity financing. B. If a company pays a small dividend, it will thereby: 1. Have a high retention of profits within the firm. 2. Not need to rely heavily on a new common stock issue for equity financing. The profits retained for reinvestment will provide the needed equity financing. II. The importance of a firms dividend policy depends on the impact of the dividend decision on the firms stock price. That is, given a firms capital budgeting and borrowing decisions, what is the impact of the firms dividend policies on the stock price? III. Three views about the importance of a firms dividend policy. A. View 1: Dividends do not matter. 1. Assume that the dividend decision does not change the firms capital budgeting and financing decisions. 158 2. Assume perfect markets which means: a. There are no brokerage commissions when investors buy and sell stocks. b. New securities can be issued without incurring any flotation cost. c. There is no income tax, personal tax, or corporate tax. d. Information is free and equally available to all investors. e. There are no conflicts of interest between management and stockholders. 3. Under the foregoing assumptions, it may be shown that the market price of a corporations common stock is unchanged under different dividend policies. If the firm increases the dividend to its stockholders, it has to offset this increase by issuing new common stock in order to finance the available investment opportunities. If on the other hand, the firm reduces its dividend payment, it has more funds available internally to finance future investment projects. In either policy, the present value of the resulting cash flows to be accrued to the current investors is independent of the dividend policy. By varying the dividend policy, only the type of return is affected (capital gains vs. dividend income), not the total return. B. View 2: High dividends increase stock value....
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This note was uploaded on 10/25/2009 for the course FI 360 taught by Professor Tavbin during the Spring '08 term at Park.
- Spring '08