Question

Dividend and Repurchase Policy a. Explain the conditions under which dividend payout policy will be irrelevant to the value of the firm. b. Provide examples of how failure of the conditions from (a) to hold will impact the firm's dividend payout decision. c. Why might an investor prefer a firm to repurchase shares, rather than pay a dividend?

Answer 1

a. Following are the conditions under which dividend payout policy will be irrelevant to the value of firm

i) Perfect capital market which means there is no flotataion cost and transaction cost for security and all information related to market is publicaly available.

ii) When there is no taxes so that it can't make any difference on payment of dividend or capital gain on shares.

iii) When there is no risk involved with the project and there is certain return and investors do not have any expectations.

b.In case the above conditions not fullfilled it will impact the firms dividend policy.

i) In case flotataion cost and transaction cost are involved in transaction investor will expect return from investment in the form of dividend.

ii) In case the rate of tax is more on dividend payment in comparison to capital gain taxes then investor will prefer dividend.

iii) In case when there is uncertainties regarding future and there is no certain return on investment investor would prefer dividend.

c. In case where firm wants to repurchase it's shares it seems to shareholders that company has additional cash in hand and firm instead of investing in alternate project or growth of current project company wants to pay it which means company has very less future prospects and price of the share of the company will fall in future so it will be better to relise it now rather than accepting dividend of lower amount.