Understanding the Core Concepts of Cash Distribution and Capital Structure: An Explanation of Dividend Policy Theories
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The purpose of this assignment is to explain core concepts related to cash distributions and capital structure. Read the Chapter 14 Mini Case in Financial Management: Theory and Practice. Using comple
The purpose of this assignment is to explain core concepts related to cash distributions and capital structure.
Read the Chapter 14 Mini Case in Financial Management: Theory and Practice. Using complete sentences and academic vocabulary, please answer questions a 1 and 2
Create a 2-3 slide PowerPoint presentation in which you summarize your answers from the mini case. Be sure to include graphs, charts, and trends as appropriate.
Integrated Waveguide Technologies (IWT) is a 6-year-old company founded by Hunt Jackson and David Smithfield to exploit metamaterial plasmonic technology to develop and manufacture miniature microwave frequency directional transmitters and receivers for use in mobile Internet and communications applications. IWT’s technology, although highly advanced, is relatively inexpensive to implement, and its patented manufacturing techniques require little capital as compared to many electronics fabrication ventures. Because of the low capital requirement, Jackson and Smithfield have been able to avoid issuing new stock and thus own all of the shares. Because of the explosion in demand for its mobile Internet applications, IWT must now access outside equity capital to fund its growth, and Jackson and Smithfield have decided to take the company public. Until now, Jackson and Smithfield have paid themselves reasonable salaries but routinely reinvested all after-tax earnings in the firm, so dividend policy has not been an issue. However, before talking with potential outside investors, they must decide on a dividend policy.
Your new boss at the consulting firm Flick and Associates, which has been retained to help IWT prepare for its public offering, has asked you to make a presentation to Jackson and Smithfield in which you review the theory of dividend policy and discuss the following issues.
What is meant by the term “distribution policy”? How has the mix of dividend payouts and stock repurchases changed over time?
The terms “irrelevance,” “dividend preference” (or “bird-in-the-hand”), and “tax effect” have been used to describe three major theories regarding the way dividend payouts affect a firm’s value. Explain these terms, and briefly describe each theory.
(1) Distribution policy, also known as dividend policy, refers to the process by which a company decides how much profit it will return to its shareholders in the form of dividends, and how much it will retain for reinvestment in the business. Historically, companies primarily used dividends as a means of distributing profits to shareholders. However, in recent years there has been a shift towards stock repurchases as a way of returning value to shareholders. The mix of dividends and stock repurchases can change over time depending on the company’s financial position and future investment opportunities.
(2) The “irrelevance” theory of dividend policy, proposed by Modigliani and Miller in the 1960s, states that a company’s dividend policy has no impact on its overall value. They argue that the market is efficient, and investors can obtain the same returns by reinvesting dividends in the company’s stock. The “dividend preference” or “bird-in-the-hand” theory posits that investors prefer to receive dividends in cash because they are more certain of the return, and therefore companies that pay dividends will have a higher stock price. Lastly, the “tax effect” theory suggests that taxes on dividends make them less attractive to investors and that companies that pay dividends will have a lower stock price because of the tax effect.
It’s worth to mention that the MM theory were challenged with more recent findings in finance, including behavioral finance and the fact that companies are not homogeneous, the capital structure is not the same for all firms. So the conclusion about dividend policy will vary by company and its specific situation.