Saturday, January 11, 2020

Options And Corporate Finance Essay

In a perfect world, the stock price will drop by the amount of the â€Å"special one- time† dividend on the ex-dividend date. If we ignore taxes as we do in this mini- case the wealth of the shareholders doesn’t change if the company pays a special one-time dividend or not because it is reflected in the stock price. As we also saw in class that a dividend policy for a company is irrelevant since investors can convert share to cash or create their own homemade dividends payments if they prefer an income stream. In essence, paying the dividend is transferring money from the company to the shareholders but net the wealth of the shareholder stay the same due to a similar drop in the share price, but the value of the company will decrease. 2. The proposal of Jessica could go both ways, it could increase the value of the company or decrease the value, for the simple reason that we don’t have any information about leverage, the amount of debt, capital structure etc. If the company is overleveraged that will result in extra costs of financial distress, which consist of direct, indirect and agency costs. An overleveraged company goes past the optimal point and will decrease in value as you can see from the red line. If this is the case then it would be a good idea to reduce the amount of debt which results in a reduction of costs related to financial distress and invest the money in new facilities to increase the overall value of the company. If the company didn’t reach it equilibrium point than it would be a bad idea to reduce the amount of debt because it will decrease the value of the company due to the tax advantages (tax shield), so it would be better to keep the amount of debt to and maybe even increase the debt to reach the maximum company value. This are two options which can increase or decrease the value of the company. Another point could be that we don’t know about future prospect of the current technology and if there is enough demand, and if they now use their full production capacity. If not the case then it would be a bad idea to upgrade and expand, but it would be better to invest in research for new technology. 3. Nolan is correct in the sense that all three indicators will increase due to share repurchase. It will increase the P/E ratio because there are less shares available and it will reduce the denominator of both ROA and ROE which will result in an increase in both ratios. However, a share repurchase will not have any effect on the value of the company for the reasons we discussed in question 1, which is that the dividend policy is irrelevant to the value of the company and it won’t have any effect on the wealth of shareholders. 4. When a company starts with a dividend policy it gives a signal to the shareholders/investors that they are committed to distribute part of their income to their shareholders. If they would start with regular dividend payments they should be sure that they are able to continue that forever, because a reduction in dividend or if they stop paying dividend at all at a later stage will send a negative signal to the market and shareholders/investors. So, they need to make sure that they have enough cash to keep the dividend policy going. To come back to the question, I would evaluate it regarding the company’s ability to pay the dividend for an infinite time period and I they will have enough cash in the future or generate enough cash in the future to pay the dividends. 5. If the company wants to expand (and it is able to do so) the trade-off is lower dividends to their shareholders than when they are a mature company who has no growth potential than they would pay dividend. The implications of the formula are that the company should make a trade-off/decision between company growth or pay the dividend to its shareholders. To please its shareholders and to maximize the company’s value, the company should deliver the required rate of return which is wanted by the shareholders or deliver a higher return to make the shareholders happy. If the company can have a higher rate of return than wanted by the shareholders it should retain earnings to invest in the growth to increase the rate of return, when this is not possible it should pay the shareholders their dividend to give them their required rate of return. But if the company retain its earnings when the rate of return is lower than wanted by the shareholders it lowers the company’s value .

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