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Financial Management Case Study Assignment

Question 1 What is meant by the term "distribution policy"? How has the mix of dividend payouts and stock repurchases changed over time?

Solution:
Distribution policy is considered to be the decision of distributing profits among the investors and also reinvesting into the company. The policy consists of important points such as paying higher rates or not, irregular or constant dividends, announcing the policy and paying dividends in long term or short term (Block, 2019).

The distribution policy can be carried out through either stock repurchases or dividend payouts. The payout amount relies on how much is needed for retaining the investment opportunities in the future. The dividend payout has been decreased and stock repurchases have been increased over the years.

Question 2 The terms "irrelevance", "dividend preference", and "tax-effect" have been used to describe three major theories regarding the way dividend payouts affect a firm's value.

Solution:
Dividend irrelevance is referred to the theory depicting shareholders are indifferent between capital gains and dividends which makes dividend policy not relevant with respect to the impact on the overall value of the organization. Bird in the hand theory states shareholders prefers dividends from share investing to gain capital due to the inherent uncertainties associated with the capital gains (Kimmel, 2018). K.Ramaswamy and R.H. Litzenberger introduced the tax effect theory. The theory states that investors choose lower payout organizations for tax reasons.

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MM proposed the dividend irrelevance theory and made some restrictive assumptions in order to prove it. It was argued by MM that paying dollar on each dividend share decreases the rate of growth of dividends and earnings because the new share would need to be sold for replacing dividend's capital paid out amount (Phylaktis, 2014). A dollar dividend under this assumption would decrease the price of the stock by $1. Thus, stockholders as per MM should indifferent between capital gains and dividends. John Lintner and Myron Gordon determined bird in hand theory. They argued investors perceive that the amount dividends in hand are considered to be less risky than the actual dividend amount to the retained earnings amount. Tax effect theory states low payouts means high gain from the capital. The capital gain tax is deferred till it is realized and they are to be taxed at the lower effective rate in comparison to dividends.

Question 3 What do the three theories indicate regarding the actions management should take with respect to dividend payouts?

Solution:
If the management accepts dividend irrelevance theory then dividend payouts would have no consequences and the organization can carry out any process of dividend payouts. If the management accepts bird in hand theory then the organization should adopt high payout policy in order of maximizing the price of the stock (Watson and Head, 2019). If the management accepts tax effect theory then the organization should adopt low payout in order to maximize the price of stock.

Question 4 What results have empirical studies of the dividend theories produced? How does all this affect what we can tell managers about dividend payouts?

Solution:
The empirical studies have provided a mixed result about the dividend theories. The dividend theories show the different procedure of maximizing the price of the stock. The managers have to make a decision of choosing the most appropriate dividend payout theory in order to carry out the process efficiently.

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Question 5 Discuss the effects on distributions policy consistent with: (1) the signaling hypothesis and (2) the clientele effect.

Solution:
Different dividend payout rules are being preferred by different clienteles or groups. For example, pension funds, university endowment funds, and retirees are in the low tax brackets. This stockholder groups mostly prefers the high payout stocks. The investor having high earnings and in the high tax brackets mostly prefers the low payout stocks. MM has argued that a clientele can be good to another and existence of them do not depict that the dividend polices are better than one another. The shift in the stockholder occurs when the policy is altered and movements result in capital gain taxes and transaction costs (Holton, 2012). It is being found that the announcement of rise in dividend leads to rise in the price of stock and announcement of a declinein the dividend leads to a decrease in the price of the shares. The examination supports that the shareholders prefer the dividends for capital gains. It is argued MM that the announcements of dividend are the method enables the management to convey necessary information to the investors.

Presentation

Distribution policy

Distribution policy is considered to be the decision of distributing profits among the investors and also reinvesting into the company.

The policy consists of important points such as paying higher rates or not, irregular or constant dividends, announcing the policy and paying dividends in long term or short term (Block, 2019).

Mix of stock repurchases and dividend payouts
The distribution policy can be carried out through either stock repurchases or dividend payouts.
The payout amount relies on how much is needed for retaining the investment opportunities in the future.
The dividend payout has been decreased and stock repurchases have been increased over the years.

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Irrelevance, tax effect, and bird in the hand
Dividend irrelevance is referred to the theory depicting shareholders are indifferent between capital gains and dividends which makes dividend policy not relevant with respect to the impact on the overall value of the organization.
Bird in the hand theory states shareholders prefers dividends from share investing to gain capital due to the inherent uncertainties associated with the capital gains (Kimmel, 2018).
K.Ramaswamy and R.H. Litzenberger introduced the tax effect theory. The theory states that investors choose lower payout organizations for tax reasons.

Describing the theories
MM proposed the dividend irrelevance theory and made some restrictive assumptions in order to prove it.
It was argued by MM that paying dollar on each dividend share decreases the rate of growth of dividends and earnings because the new share would need to be sold for replacing dividend's capital paid out amount (Phylaktis, 2014).
A dollar dividend under this assumption would decrease the price of the stock by $1. Thus, stockholders as per MM should indifferent between capital gains and dividends.
John Lintner and Myron Gordon determined bird in hand theory. They argued investors perceive that the amount dividends in hand are considered to be less risky than the actual dividend amount to the retained earnings amount.
Tax effect theory states low payouts means high gain from the capital. The capital gain tax is deferred till it is realized and they are to be taxed at the lower effective rate in comparison to dividends.

Actions of the management
If the management accepts dividend irrelevance theory then dividend payouts would have no consequences and the organization can carry out any process of dividend payouts.
If the management accepts bird in hand theory then the organization should adopt high payout policy in order of maximizing the price of the stock (Watson and Head, 2019).
If the management accepts tax effect theory then the organization should adopt low payout in order to maximize the price of stock.

Results
The empirical studies have provided a mixed result about the dividend theories.
The dividend theories show the different procedure of maximizing the price of the stock.
The managers have to make a decision of choosing the most appropriate dividend payout theory in order to carry out the process efficiently.

Effects on the distribution policy
Different dividend payout rules are being preferred by different clienteles or groups. For example, pension funds, university endowment funds, and retirees are in the low tax brackets. This stockholder groups mostly prefers the high payout stocks. The investor having high earnings and in the high tax brackets mostly prefers the low payout stocks.
MM has argued that a clientele can be good to another and existence of them do not depict that the dividend polices are better than one another. The shift in the stockholder occurs when the policy is altered and movements result in capital gain taxes and transaction costs (Holton, 2012).
It is being found that the announcement of rise in dividend leads to rise in the price of stock and announcement of a declinein the dividend leads to a decrease in the price of the shares. The examination supports that the shareholders prefer the dividends for capital gains. It is argued MM that the announcements of dividend are the method enables the management to convey necessary information to the investors.

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