Fairly Simple Dividends Questions

or so I thought…!! Q1. Assume that a company is based in a country that has no taxes on dividends and capital gains. The company is considering either paying a special dividend or repurchasing its own shares. Shareholders of the company woul have A. greater wealth if the company paid a special cash dividend B. greater wealth if the company repurchased its shares C. the same wealth under either a cash dividend or share repurchase program D. less wealth under either a cash dividend or share repurchase program Q2. Which of the following factors would NOT tend to be associated with company having a low dividend payout ratio? A. Restrictive debt covenants B. High flotation costs on new equity issues C. High tax rates on dividends D. Low growth prospects

  1. C investors should be indifferent since taxes are the same. 2. D; A and C are out. I don’t know how B would be effected, so thats why I chose D.

Just guessing: Q1: C Q2: D

1C 2B

Alright I’ll give it a whirl 1) C Investor preference could differ but wealth should be equal 2) D Low growth/Mature companies should have high div payout. B is not right because if float costs are high (i.e. issuing new shares) than retained earnings are a cheaper form of capital and thus they would want to retain them to reinvest and thus have low div payout.

c… absolutely word for word from reading. D… but that’s from a reading though. in theory, low dividend payout should be high growth, but asness/arnott found empirically that’s not the case. … also, restrictive debt covenants is usually NOT why firms have low payout ratios, but it could be the reason… I’D GO FOR BAD QUESTION… EDIT: MISREAD 2ND QUESTION, ALTHOUGH SAME PROBLEM. theory is low payout = high growth. empirical = opposite. i do think theory should win.

ok I don’t want to give the answer out yet… i do have another question though… For Q1. why are you all saying C? When they are referring to shareholder wealth won’t it be greater if the investor gets a cash dividend vs a share repurchase. I mean if he gets a cash dividend his total wealth = share price + Cash dividend if the share repurchase program is done his total wealth = Cash dividend ONLY ( since he no longer holds the share) right??

Share price b/f div = share price after div + Div

Yes, but share price drops with the exportation of equity via cash dividend so that share price after dividend plus dividend = pre dividend price. When dealing with securities, on the first day ex coupon or ex dividend, the price will drop by exactly the amount of the dividend. Edit: Planner beat me to it.

Share Price would drop if they pay a dividend so total wealth would be equal. I would go with: 1.C 2.D Edit: Damn, I’m so slow

oh yesssss…I keep forgetting that…Share price right after dividend is reduced by the Dividend amount… makes sense now… Anyway…correct answers Q1. C Q2. D Again…I’m not sure I understand why D is the answer for the second question…if a company has low growth, won’t that mean they’ll pay low dividends in order to retain their earnings and invest in better opportunities for growth??? Although for Q2 the other three can be eliminated for being wrong…I just need to understand why D is correct…

If a company doesnt have any growth, no investors would invest in it unless they were attracted by the higher dividents

I say A for # 1 - bird in the hand theory. Cash is more valuable than the future potential earnings of equity in the firm. Not sure about this one though, I just think C is the easy answer and he said this is a tricky question. For # 2: I agree with D. Low growth/mature equals high dividend as was already stated. EDIT: OK so I posted my answer right as he posted the correct one. I’ll agree with C for the first problem but that was not a tricky question then!

Also, you do have a point with your argument but I think you got it backwards. If the growth prospects are high, then the company would pay low dividends and instead invest their retained earnings in the investment opportunities

Can someone chime in on whether the price the company pays to repurchase its shares will affect shareholders’ wealth?

for #2, when they say “low growth”, they mean no high-growth opportunities do use they money for. if they dont have good projects to invest in, its better to pay a dividend

Dwight Wrote: ------------------------------------------------------- > I say A for # 1 - bird in the hand theory. Cash > is more valuable than the future potential > earnings of equity in the firm. Not sure about > this one though, I just think C is the easy answer > and he said this is a tricky question. > > For # 2: I agree with D. Low growth/mature > equals high dividend as was already stated. > > EDIT: OK so I posted my answer right as he posted > the correct one. I’ll agree with C for the first > problem but that was not a tricky question then! hahaha…sorry Dwight! I didn’t mean to throw you off there by implying the question was tricky…I thought it was an easy question…yet missed the minute details :slight_smile: that’s all!

C, D

oops, didn’t see that the correct answers had been posted.

gz2nyc Wrote: ------------------------------------------------------- > Can someone chime in on whether the price the > company pays to repurchase its shares will affect > shareholders’ wealth? Yes, that is a key distinction, repurchase is only equivalent to cash dividend if it takes place @ market price. If above it destroys shareholder wealth, below market, it adds to shareholder wealth.