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Unformatted text preview: ear to be superior. It is reasonable to assume that if the dividend is retained and
invested, g will increase, and intuitively we believe it should increase sufficiently to produce a total
return greater than before, but there is no hard evidence that it will do so. 92
3. Don’s argument rests on the principle that the capital budget, as well as the dividend, must be paid for
solely out of net income for the current year, and, of course, this is not so. It is the amount of cash
available that is the limiting factor. Referring to Figure 1, we see that Montgomery’s cash balance for
2005 is $3,235 million, so that is the maximum size that the capital budget plus dividend payment can
be without selling off assets or seeking outside financing. (This is an important point.) We often
speak of financing the capital budget, or indeed, paying dividends, out of retained earnings. We tend
to speak of retained earnings as if they were cash. They are not, of course; only claims on assets, of
which cash is but one. If retained earnings were to be entirely used up in financing the capital budget,
then some of the firm’s assets would have to be sold in the process.
4. a. The cost of internal equity f...
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This note was uploaded on 12/21/2012 for the course FINC 309 taught by Professor Bunker during the Spring '12 term at Westminster UT.
- Spring '12
- Corporate Finance