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67 firmapaysnodividendbpaysadividendof10

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Unformatted text preview: avoring a Low Payout Tax Consequences: Companies can convert dividends into capital gains by shifting their dividend policies A firm that adopts a low payout ratio will reinvest the reinvest the money in positive NPV projects. If dividends are taxed more heavily than capital gains, taxpaying investors should welcome such a move and value the firm more favorably. 27 Some Real World Factors Favoring a Low Payout Tax Consequences: In addition, capital gains tax is deferred until the stock is sold This makes the effective capital gains tax much lower because the present value of the tax is less In such a tax environment, the total cash flow retained by the firm and/or held by shareholders will be higher than if dividends are paid Investors should accept a lower pre‐tax rate of return from securities offering returns as capital gains Tax Consequences: An example 28 Suppose dividends are taxed at 50% where capital gains are taxed at 20% Two firms, A and B, are equally risky i.e. they have the same after‐tax required rate of return Yet the price of firm A’s stock is $100 and Firm B’s is $96.67 Firm A pays no dividend; B pays a dividend of $10 The current tax regime implies that the pre‐tax return offered by B must be higher than that offered b...
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