In equity method, dividend are reducing investment in balance sheet and income is increasing this investment.
What will happen if company pays more dividend than company is getting in form of income?
I mean at one point may be original investment will get zero and investment on balance sheet is just representing net of dividend and income.
Then the value of your investment will decline.
Suppose that you pay $10 million for 40% of Company S (so the book value of its equity is roughly $25 million). It has net income of, say, $1 million per year, and suppose that it pays out $1.5 million in dividends. Your share of the income is $400,000, and of the dividends, $600,000; thus, your investment will decline by $200,000. At that rate, it will take 50 years for the value of your investment to drop to zero; in that time, Company S will have earned $50 million and paid out $75 million in dividends.
Seems unlikely.
(Oh, and notice what the book value of Company S’s equity will be at the end of 50 such years.)
S2000magician I understand your point but sometimes companies do pay more dividend by utilising their historical retained earnings and may be proportion could be very high.
This question was just ringing my mind I thought may be there is something and I do not know.
That’s why I answered your first question: the value of your investment will decline. You’re correct: sometimes they do it. But they cannot sustain it; thus, you needn’t worry that the value of your investment will drop to zero or below.
That’s a good reason to ask a question.
My pleasure.