Depending on its life cycle and strategy, a firm has different financial needs. These financial needs could be fulfilled by internal or external resources. The sources of internal financing is cash flows. External financing could be debt and/or equity. When a firm uses debt, the interest rate it pays is the remuneration of the lenders (i.e. banks). In the case of equity it is different, the firm does not have to pay a contractual interest rate. The shareholders' profit depends on the company's performance. This profit is determined by the gap between the amount they invested at a time period t to get a given number of share X and the value of these shares at a time period t+n. A stockholder realizes a capital gain when the value of the shares he holds is higher than the value at which he has purchased them. A shareholder could also get dividends. A dividend is a payment in cash or in stocks made by a company to its stockholders.
[...] Figure Dividend Payout Ratios in G-7 Contries, 1982-84 and 1989-91 As one can see in figure Japan paid the lowest dividend in percentage of its earnings during the two periods considered, which is consistent with the previous proposition, because during these two periods Japan was the member of the G-7 with the highest expected growth rate The impact of the tax rate Dividend policy does not only depend on the stage of growth. Other factors such as tax treatment can affect the dividends policy. [...]
[...] The dividends policy irrelevance This proposition was initiated by Miller and Modigliani. It argues that dividend payout is irrelevant and that shareholders are indifferent about having dividends. But this argument is valid under some assumptions: 1. Conditions of validity The theory is as follows, if a firm pays dividends, it will impact negatively its stock price. As a consequence, a stockholder is indifferent about receiving dividend, because what he wins on one hand, he loses it on the other. This is true if: Dividends and the gains from stock selling have an identical tax rate or if there are no taxes. [...]
[...] very low. At this stage, the firm can't pay dividends because it needs funds to finance its projects. At the second stage, the firm is no longer a start up, it is in rapid expansion. During this period, the firm's external funding needs are still high and it hasn't enough internal financing resources. As a consequence, the firm can't pay dividends. The third stage is a high growth stage. The firm's external funding needs are moderate and its internal financing capability is low relative to funding needs. [...]
[...] Total Value per Share = Price per Share + Dividend per Share = 9.523 + 0.953 = 10.476 This scenario shows us that for a shareholder, a dividend policy does not matter if it does not affect the N.O.P.A.T, because eventually he receives the same amount. The only difference is the composition of what he gets. Scenario KIANO stops dividends distribution Assuming that KIANO stops dividends distribution, the value of the firm to the old shareholders will be: Value of the firm = Present value of after tax operating cash flows + cash = 50 + 0.05 ) / (WACC + 50 million = 50 + 0.05 ) / ( 0.10 0.05 ) + 50 million = 1100 million Value per Share = 1100 million / 105 million share = 10.48 By following this reasoning and changing the amount of dividend distributed, table 1 can be devised. [...]
[...] The irrelevance of the dividends policy means that a firm cannot create value through its dividend policy. Unfortunately, the assumptions used to demonstrate this proposition are unrealistic. However, it can be noted that this proposition, in spite of its weaknesses shows that a firm cannot hide its deficiencies to shareholders by paying them dividends. This is true because a firm without a goods project, which realizes bad investments cannot not achieve high performance. Without good performances, a firm cannot get enough money to distribute dividends. [...]
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