what does it refer to? in page 179, question 7, thanks.
cost involved in issuing new equity, so if floatation cost is high, one would rather not pay dividends, since internally generated funds will be cheaper.
mainly associated with Investment Banks, they help a firm raise equity capital and charge a fee for it known as floatation cost so ideally a firm would prefer internally generated funds to fulfill its capital needs
But why would there be ANY floatation cost if the firm is simply pondering whether paying dividends on EXISTING equity (whose floatation costs were already paid when that equity was first issued)???
paying dividends as cash, or as stock dividends?
I believe if it is stock dividends - there is new equity to be issued (or converted).
I guess is related to *cash* dividends but it’s still a bit confusing…
Please note that the Schweser notes indicate basically that “the higher the floatation costs the lower the dividend payout.”
So it seems to refers to two events: FIRST an equity issuance with floatation cost involved and THEN a dividend consideration follows.
How does the first event in the past affect the dividend decision in the future?
flotation costs cause external equity to be costlier than internal equity (retained earnings).
so a preferred mode would be to use the internally generated earnings *retained part* and decrease dividends instead of issuing new equity.
Firms issue equity to generate funds. If cost of issuing those stocks (flotation cost) is high then they prefer to generate funds internally through retained earnings. Net Income can either be retained or distributed through cash dividends or treasury stock method. If dividends are decreased then funds could be generated internally instead of issuing new equity.
Flotation cost makes it more expensive for companies to raise new equity capital. Many companies avoid creating a level of dividend that would create a need to raise new equity to finance +npv projects.
So we would not pay dividends if flotation cost is high since it reduces the buffer we have for investing in +npv projects and then we may have to issue equity which has high costs. Thus a firm may prefer to save on internally generated funds rather than issue dividends.