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    The Determinants of Dividend Policy

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    Shahnewaj Shaan
    This document discusses factors that influence a company's dividend policy, including: - Companies try to maintain consistent dividend payments and are reluctant to cut dividends due to negative market reactions. - Cutting dividends is seen as a sign of financial trouble and causes stock prices to drop sharply. - Dividends are less relevant if firms can raise capital easily with no transaction costs. - Dividends were less tax advantaged in the past for high-income investors in the U.S. - Cutting dividends may cause stock prices to drop as existing shareholders sell their stock. - Increasing dividends signals management confidence in future cash flows, raising stock valuation.

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    Download as PDF, TXT or read online from Scribd

    The Determinants of Dividend Policy

    Uploaded by

    Shahnewaj Shaan
    21 views4 pages
    This document discusses factors that influence a company's dividend policy, including: - Companies try to maintain consistent dividend payments and are reluctant to cut dividends due to negative market reactions. - Cutting dividends is seen as a sign of financial trouble and causes stock prices to drop sharply. - Dividends are less relevant if firms can raise capital easily with no transaction costs. - Dividends were less tax advantaged in the past for high-income investors in the U.S. - Cutting dividends may cause stock prices to drop as existing shareholders sell their stock. - Increasing dividends signals management confidence in future cash flows, raising stock valuation.

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    chapter 21 solution

    Original Title

    21 Dividend Policy

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    This document discusses factors that influence a company's dividend policy, including: - Companies try to maintain consistent dividend payments and are reluctant to cut dividends due to negative market reactions. - Cutting dividends is seen as a sign of financial trouble and causes stock prices to drop sharply. - Dividends are less relevant if firms can raise capital easily with no transaction costs. - Dividends were less tax advantaged in the past for high-income investors in the U.S. - Cutting dividends may cause stock prices to drop as existing shareholders sell their stock. - Increasing dividends signals management confidence in future cash flows, raising stock valuation.

    Copyright:

    © All Rights Reserved
    Download as PDF, TXT or read online from Scribd
    Download as pdf or txt
    21 views4 pages

    The Determinants of Dividend Policy

    Uploaded by

    Shahnewaj Shaan
    This document discusses factors that influence a company's dividend policy, including: - Companies try to maintain consistent dividend payments and are reluctant to cut dividends due to negative market reactions. - Cutting dividends is seen as a sign of financial trouble and causes stock prices to drop sharply. - Dividends are less relevant if firms can raise capital easily with no transaction costs. - Dividends were less tax advantaged in the past for high-income investors in the U.S. - Cutting dividends may cause stock prices to drop as existing shareholders sell their stock. - Increasing dividends signals management confidence in future cash flows, raising stock valuation.

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    Download as PDF, TXT or read online from Scribd
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    of 4

    CHAPTER 20:

    THE DETERMINANTS
    OF DIVIDEND POLICY

    20-1
    a. True

    b. True

    c. False

    20-2
    Firms usually do not change their dividends very frequently. This is what is meant by
    sticky dividends. Part of the reason for sticky dividends is that firms are reluctant to cut
    dividends, because of the fear that markets will punish them. Consequently, they do not
    increase dividends unless they believe that they can maintain these higher dividends.

    20-3
    Cutting dividends may send a very negative signal to markets. When firms announce that
    they will be cutting dividends, markets assume the worst, i.e., that the firm is in serious
    financial trouble, and the company's stock price usually drops sharply.

    a: It could increase more than a dime or less than a dime. It depends on the perception of
    the market on changes in future dividends.

    b: Earnings can go up and down without theoretical boundaries while the dividends
    cannot go below zero.

    20-4
    If there are no tax differences in the treatment of dividends and capital gains, and firms
    can raise external financing at little or no cost, it can be argued that dividends are
    irrelevant. Large, financially strong firms with primarily tax-exempt or low-tax rate
    investors may fit this description best.

    20-5
    No. This tax disadvantage was particularly applicable in the United States prior to 1986
    for high-tax rate individual investors. It does not apply to tax exempt investors or to
    corporations.

    20-6
    It should reduce the amount it pays in dividends. The problem it might run into is
    communicating this intent to the market. Since its existing stockholders like dividends,
    the announcement is likely to lead to some of them selling the stock, causing the stock
    price to drop.

    20-7
    An increase in dividends suggests to markets that the firm has the confidence that its
    future cash flows will be high enough to continue making these dividend payments. This
    confidence is the positive signal that might lead markets to increase their assessment of
    the firm's value. The empirical evidence is supportive, with stock prices increasing on
    dividend increases.

    20-8
    Yes. If a firm that is believed to have great projects/high growth prospects increases
    dividends, it may send the signal that its project choice is narrowing. There seems to be
    no empirical evidence to support this hypothesis, though.

    20-9
    (Price before - Price After) / Dividends = (1 - to) / (1 -. tcg), i.e., 3.5/5 = (1- to)/(1 -.4)
    Solving for the ordinary tax rate, ordinary tax rate = to = 1 - .6*3.5/5 = 58%

    20-10
    If the marginal investor (which is a corporation) sells the stock before the ex-dividend
    day,
    CFB = PB - (PB - P) tcg
    If the marginal investor sells the the stock after the ex-dividend day,
    CFA = PA - (PA - P) tcg + D (1 - 0.15 to)
    If no arbitrage is allowed to occur,
    CFB = CFA
    Then we find (PB - PA) / D = (1 - 0.15 to) / (1 - tcg )

    20-11
    Company Price Dividend Price
    change change/Dividend
    NE Gas 2 4 0.5
    SE Bell 3 4 0.75
    Western Elec. 5 5 1

    As a tax-exempt investor, you make returns based upon the difference between the price
    drop and the dividend. Consequently, you will make excess returns on the first two
    stocks. On both an absolute and percentage basis, NE Gas is your best bet.

    20-12
    Assume that the true capital gains tax rate = Stated Rate/(1+Rf)n
    (Pb - Pa) = (1 - to) / (1- tcg) or ($10 - $9.20) = (1-.5) / (1-.5/1.1n)
    Solving for n, n = approximately 3 years

    20-13
    Tax rate on dividends = (40%) (.15) = 6%
    Tax rate on capital gains = 28%
    Expected price drop on ex-dividend day = ($0.50) (1-.06)/(1-.28) = $0.65

    20-14
    I would expect the price to drop since the actual price increase of 4% is less than the
    expected (or usual) price increase of 5%.

    20-15
    The stock price may react negatively. The dividend may signal that Microsoft's project
    choice is becoming less attractive, and this will have negative consequences for future
    growth and project returns. In addition, stockholders in Microsoft are likely to be oriented
    to capital gains and may not like the dividends.

    20-16
    I would expect the price reaction to be positive. The price increase in this case may send
    a positive signal to financial markets. The answer is different from the previous problem,
    because the auto parts industry is a more stable one than the software business (reducing
    the negative signaling implications of the dividend increase). Furthermore, the fact that
    the company already pays a substantial dividends implies that its stockholders will be less
    averse to receiving more in dividends.

    20-17
    The price reaction will be more muted. Since the 35 analysts following the firm are likely
    to dig up any positive information about the company, the dividend increase at the
    margin conveys less information than it would for a smaller firm.

    20-18
    I would expect it to decline. The preceding news on earnings and revenues has probably
    already conveyed the message that the firm is in financial trouble to financial markets.
    The decline in dividends, however, may cement this message by indicating that
    management believes that the earnings decline is not a short term phenomenon.

    20-19
    I would expect the stock price reaction to be positive. The fact that RJR Nabisco was
    under stockholder pressure to begin with suggests that their assets were making below-
    market returns. Selling such assets would therefore be a positive action; returning the
    cash to stockholders would add to this reaction because it eliminates the chance that this
    cash will be invested in other poor projects.

    20-20
    I would expect bond prices to drop. Selling assets (especially liquid ones) and paying
    dividends makes these bonds much riskier.
    20-21
    This incentive scheme would discourage the management from paying dividends because
    paying dividends would reduce the price of the stock and reduce the value of options to
    the managers.

    20-22
    Firms’ dividend policy would be affected in different ways because the clientele of each
    firm may be in different tax bracket today.

    20-23
    The U.S. government may want to encourage capital formation in corporations.

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