Director A is in favour of financing all investment by retainedearnings and other internally generated funds....

 

 

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Director A is in favour of financing all investment by retainedearnings and other internally generated funds. He argues that a highlevel of retentions will save issue costs, and that declaring dividendsalways results in a fall in share price when the shares are traded exdiv. Director B believes that the dividend policy depends upon the typeof shareholders that the company has, and that dividends should be paidaccording to shareholders' needs. She presents data to the boardrelating to studies of dividend policy in the USA, and a breakdown ofthe company's current shareholders. Company group (10 companies per group) 12345 USA dividend research Mean dividend yield Pension funds Insurance companies Unit and investment trusts Nominees Individuals % 7.02 5.18 4.17 3.52 1.26 Deerwood Inc Number of shareholders 203 41 53 490 44,620 45,407 Average marginal tax rate of shareholders Analysis of shareholding % of total shares held 25.1 5.1 Shares held (million) 38.4 7.8 18.6 32.4 55.9 % 16 22 25 33 45 153.1 12.1 21.2 36.5 100.0 She argues that the company's shareholder "clientele' must beidentified, and dividends fixed according to their marginal taxbrackets. Director C agrees that shareholders are important, but points outthat many institutional shareholders and private individuals rely ondividends to satisfy their current income requirements, and prefer aknown dividend now to an uncertain capital gain in the future. Director D considers the discussion to be a waste of time. Hebelieves that one dividend policy is as good as any other, and thatdividend policy has no effect on the company's share price. In supportof his case he cites the dividend irrelevancy theory proposed byModigliani and Miller. Required: Critically discuss the arguments of each of the four directorsusing both the information provided and other evidence on the effect ofdividend policy on the share price that you consider to be relevant. Director A is in favour of financing all investment by retainedearnings and other internally generated funds. He argues that a highlevel of retentions will save issue costs, and that declaring dividendsalways results in a fall in share price when the shares are traded exdiv. Director B believes that the dividend policy depends upon the typeof shareholders that the company has, and that dividends should be paidaccording to shareholders' needs. She presents data to the boardrelating to studies of dividend policy in the USA, and a breakdown ofthe company's current shareholders. Company group (10 companies per group) 12345 USA dividend research Mean dividend yield Pension funds Insurance companies Unit and investment trusts Nominees Individuals % 7.02 5.18 4.17 3.52 1.26 Deerwood Inc Number of shareholders 203 41 53 490 44,620 45,407 Average marginal tax rate of shareholders Analysis of shareholding % of total shares held 25.1 5.1 Shares held (million) 38.4 7.8 18.6 32.4 55.9 % 16 22 25 33 45 153.1 12.1 21.2 36.5 100.0 She argues that the company's shareholder "clientele' must beidentified, and dividends fixed according to their marginal taxbrackets. Director C agrees that shareholders are important, but points outthat many institutional shareholders and private individuals rely ondividends to satisfy their current income requirements, and prefer aknown dividend now to an uncertain capital gain in the future. Director D considers the discussion to be a waste of time. Hebelieves that one dividend policy is as good as any other, and thatdividend policy has no effect on the company's share price. In supportof his case he cites the dividend irrelevancy theory proposed byModigliani and Miller. Required: Critically discuss the arguments of each of the four directorsusing both the information provided and other evidence on the effect ofdividend policy on the share price that you consider to be relevant.

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1 Director A effects of a residual policy advantages of using internal funds for investment impact o... View the full answer