Regional Electric has 1000 cash T bill yield is 10 T c 034 T s 028 t 5 years

Regional electric has 1000 cash t bill yield is 10 t

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Regional Electric has $1000 cash. T-bill yield is 10% T c = 0.34, T s = 0.28, t = 5 years Max tax on dividend is 0.15 Plan A: dividends are paid now shareholders receive = $1000 x (1-0.15) = $850 after tax After T s return of T-bill investing = 10% x(1- 0.28)= 7.2% The $850 dividend will yield $850 x 1.072 5 = $1,203.35
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31 Example 19.1 (Continued) Plan B: The firm retains the cash and invest in T-bill Its after tax return is 10% x (1-0.34) = 6.6% The firm will have $1000 x 1.066 5 = $1,376.53 If these are all paid to shareholders, their after tax return will be $1,376.53 x (1-0.15) = $1,170.05
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32 Example 19.1 (Continued) Hence, it is better to pay now This example shows the dividend decision depends on personal and corporate tax rates.
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33 Real-World Factors Favoring High Dividends Desire for Current Income Behavioral Finance It forces investors to be disciplined. Tax Arbitrage Investors can create positions in high dividend yield securities that avoid tax liabilities. Real World Factors Favoring High Dividends
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34 Real-World Factors Favoring High Dividends Agency Costs High dividends reduce free cash flow. Information Content of Dividends and Dividend Signaling Real World Factors Favoring High Dividends
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35 The Clientele Effect Clienteles for various dividend payout policies are likely to form in the following way: Group Stock Type High Tax Bracket Individuals Low Tax Bracket Individuals Tax-Free Institutions Corporations Zero-to-Low payout Low-to-Medium payout Medium payout High payout Once the clienteles have been satisfied, a corporation is unlikely to create value by changing its dividend policy. The Clientele Effect
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36 What We Know and Do Not Know Dividends are substantial Corporations smooth dividends. Fewer companies are paying dividends. Dividends provide information to the market. What We Know and Do Not Know about Dividend Policy
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37 What We Know and Do Not Know Firms should follow a sensible policy: Do not forgo positive NPV projects just to pay a dividend. Avoid issuing stock to pay dividends. Consider share repurchase when there are few better uses for the cash. What We Know and Do Not Know about Dividend Policy
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39 Revision Topics and Checkpoints What are the different types of dividends, and how is a dividend paid? What is the clientele effect, and how does it affect dividend policy irrelevance? What is the information content of dividend changes? What are stock dividends, and how do they differ from cash dividends? How are share repurchases an alternative to dividends, and why might investors prefer them?
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Back to our case…
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Source: The Standard, 4 Aug, 2016
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Think about it Why does HK Bank “waste” the cash to buy back shares given the business performance has worsened?
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  • Fall '15
  • Dividend, HK bank

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