DIVIDENDS AND DIVIDEND POLICY
Answers to Concepts Review and Critical Thinking Questions
Dividend policy deals with the timing of dividend payments, not the amounts ultimately paid.
Dividend policy is irrelevant when the timing of dividend payments doesn’t affect the present value
of all future dividends.
A stock repurchase reduces equity while leaving debt unchanged. The debt ratio rises. A firm could,
if desired, use excess cash to reduce debt instead. This is a capital structure decision.
Friday, December 29 is the ex-dividend day. Remember not to count January 1 because it is a
holiday, and the exchanges are closed. Anyone who buys the stock before December 29 is entitled to
the dividend, assuming they do not sell it again before December 29.
No, because the money could be better invested in stocks that pay dividends in cash which benefit
the fundholders directly.
The change in price is due to the change in dividends, not due to the change in dividend
Dividend policy can still be irrelevant without a contradiction.
The stock price dropped because of an expected drop in future dividends. Since the stock price is the
present value of all future dividend payments, if the expected future dividend payments decrease,
then the stock price will decline.
The plan will probably have little effect on shareholder wealth. The shareholders can reinvest on
their own, and the shareholders must pay the taxes on the dividends either way. However, the
shareholders who take the option may benefit at the expense of the ones who don’t (because of the
discount). Also as a result of the plan, the firm will be able to raise equity by paying a 10% flotation
cost (the discount), which may be a smaller discount than the market flotation costs of a new issue
for some companies.
If these firms just went public, they probably did so because they were growing and needed the
additional capital. Growth firms typically pay very small cash dividends, if they pay a dividend at
all. This is because they have numerous projects available, and they reinvest the earnings in the firm
instead of paying cash dividends.
The stock price drop on the ex-dividend date should be lower. With taxes, stock prices should drop
by the amount of the dividend, less the taxes investors must pay on the dividends. A lower tax rate
lowers the investors’ tax liability.
With a high tax on dividends and a low tax on capital gains, investors, in general, will prefer capital
gains. If the dividend tax rate declines, the attractiveness of dividends increases.