1 ) Miller and Modigliani. the middle-of-the-roaders. opined that dividend policy has no consequence on a firm’s value in a perfect and efficient capital market. The right-winger believed that dividend payout increases the value of a house ; the collectivist said that if revenue enhancements on dividend are higher than capital additions so companies should pay the lowest dividend policy and dressed ore on capital grasp ; besides that companies should utilize alternatively those monies to put for growing and development that appreciate capital. Evidence have suggested that capital markets are less than perfect due to imperfectnesss like dealing costs. fiscal hurt. the possibility of bankruptcy and the associated bankruptcy costs ; therefore connoting that dividend policy has an consequence on the value of a house. contrary to what Miller and Modigliani opinionated.
Evidence has besides suggested that the fringy revenue enhancement rates on dividends are usually higher than on capital additions and that capital additions revenue enhancement can be defer by reinvestment of the returns. Why so should companies pay dividend by following the right-wingers position? The followers are some of the ground why companies pay dividends:
•Some investors require a steady watercourse of income. It can be argued that they can hold this by selling portions ; but because of dealing costs. it is preferred for them to hold a watercourse of income alternatively. •Other investors are required to pass money out of income and non capital ; as such they can non sell portions and will therefore necessitate some dividend payments to run into care demands. •Also that investors may prefer some money now than delay to have it the hereafter because of the clip value of money ; a dollar today is greater than a dollar tomorrow. •To cut down bureau costs that arises because of the separation of direction and ownership. Management may desire to construct an imperium through the accretion of hard currency. which creates struggle by prosecuting aims that do non maximise stockholders value but increases managerial perquisite ingestion.
•Also stockholders may necessitate dividend in order to forestall direction from roll uping excessively much hard currency that they can use on undertakings with negative NPVs. if they do non happen moneymaking investing chances. •Some investors. like pension financess. do non pay revenue enhancement on dividends so the revenue enhancement statement is irrelevant to them ; as such they will necessitate dividend payout. •Companies besides pay dividend for signaling intents. That is that direction has assurance in the investing chances of the company and the future sustainability of dividend payout.
•Companies are besides usually viewed favourably through portion monetary value addition when they increase dividend or announce dividend for the first clip. Those that decrease dividend may see a autumn in portion monetary value. •Companies besides pay dividend to pull different patronages of investors that fall in different revenue enhancement brackets or for portfolio variegation. Those that fall within a lower revenue enhancement bracket are paid dividends ; those on higher revenue enhancement brackets are given other payout options that are revenue enhancement efficient. Dividends can be paid in the signifier of hard currency. belongings or stock. The advantages of hard currency dividend are:
•Earnings they are extremely liquid for investors. which they can utilize as they see fit. The other types are less liquid. •Companies that systematically pay hard currency dividends demonstrate a sense of stableness and investor respond by paying premiums for the stocks of such companies. •Cash dividends enable investors to harvest some benefits from their investing without selling their stocks ; therefore it encourages long-run ownership of the stocks. particularly for investors that require steady watercourses of hard currency. •When a company pays regular hard currency dividends its bounds the sum of losingss investor may incur in the event of a downswing as some of the investing had been recouped earlier on. Disadvantages of hard currency dividends are:
•Decrease in maintained net incomes that the company can utilize for growing and investing chances •Cash dividends are taxed instantly. where as the revenue enhancement on the others can be defer until the stocks are sold or hard currency is withdrawn from the investing belongings. •Also the revenue enhancement on hard currency dividend is comparatively higher.
•Shareholders will anticipate the company to go on paying hard currency dividends ; if the company faces hard currency flow jobs or wants to put in moneymaking chances so the company would be meeting a quandary. •Dividends are besides usually taxed twice ; first as corporate revenue enhancement and so as dividend income.
2 ) The most of import issues facing the FPL Group in May 1994 were: •The inauspicious evaluations from analysts. •The possibility of the company non being able to keep its dividend policy. •The company’s stock monetary value had fallen by 19. 6 % with the S & A ; P Electric Utilities Index fallen by 22. 1 % ; the company’s portion monetary value fell by more than 6 % in one twenty-four hours in May 5. •Negotiations between the company and the Florida Municipal Power Agency which was ordered by the Federal Energy Regulatory Commission ; this intercession was as a consequence of the judicial proceeding brought on the company by the bureau claiming that the company violated the NEPA Act of 1992 by denying the bureau entree to its public-service corporation transmittal system.
•Threat of competition if the Florida Public Service Commission considered retail Wheeling. The company would so lose some of its market portion. At that it was the largest public-service corporation company in Florida but the 4th largest in the state. Retail Wheeling allowed companies in other provinces to supply public-service corporation in other provinces. •Rising involvement rates and the possibility of an addition in the company’s beta ; this may ensue in a downgrade of its debt evaluations by Standard and Poor. •Shareholders may non sign the company’s hearers or O.K. the proposed compensation program.
3 ) The dividend payout ratio of the company = hard currency dividend/net income = 461. 639/428. 749 = 1. 0767 = 107. 67 % Or dividend payout = dividends per share/earnings per portion = 2. 47/2. 30 = 1. 0739 = 107. 39 % . For comparative intents. the dividend payout ratio of the company before extraordinary points = 2. 47/2. 75 = 89. 82 % . As per exhibit 7. the company had the highest payout ratio in the industry. From the position of the company. its so dividend payout ratio was inappropriate because it was non sustainable given the increased hazards faced by the company and the systemic hazard in the market in add-on to the issues highlighted in ( 2 ) above. Without accommodation for extraordinary points. the company had the highest payout ratio as per Exhibit 9. The company should make up one’s mind on a lower payout ratio and put the remainder on positive NPVs undertakings. It can make up one’s mind to cut down its dividend payout to at least the industry norm of 82. 9 % .
4 ) For the single investors and others who held 51. 9 % of the company’s stock. a decrease in the payout ratio should non impact their value ; this is because most of the payout was traveling into revenue enhancements. A decrease in hard currency dividend would take to capital grasp. If hard currency dividend would be replaced by stock dividend the company could still hold adequate hard currency flow to prosecute growing schemes and these stockholders would be better-off. Thus the payout ratio was inappropriate to them. For the institutional investors that owned 36. 9 % of the company’s stock. they would prefer a higher dividend payout ratio since revenue enhancement on dividend do non impact them.
Therefore this payout ratio was appropriate for them. They may even anticipate an addition in the payout ratio ; because a “bird in manus is deserving two in the bush” to them. For the ESOP investors that were utilizing the stocks as a retirement nest egg program. the payout would be appropriate based on whether the employees were retired or on active responsibility. Those on active responsibility would prefer a low payout so less revenue enhancement and high capital grasp ; those that were already retired would prefer more payout because their fringy revenue enhancement rate would so be lower and they require steady watercourses of hard currency flows for nutriment and care intents. The insiders ( officers and Directors ) would prefer a low payout as they would hold been gaining high wages already ; as such the payout ratio is inappropriate for them.
5 ) The bulk of the firm’s investors ( 63. 1 % ) would prefer a lower dividend payout ratio. Thus the consequence of a dividend cut would non impact them and in consequence non holding a significant consequence in the portion monetary value. These investors would therefore probably keep their portions. Institutional investors may bale out and put in other companies that would so hold higher payout ratios. like Texas utilities. This bale out would take the portion monetary value to fall. Thus a decrease in the dividend payout would impact the portion monetary value farther ; it was falling anyhow so the company should merely every bit much do the right thing now to cut the dividend and utilize the hard currency to put in positive NPVs undertakings or buy back the stocks at the lower portion monetary values and keep them in their exchequer. If the company would be able to place plenty positive NPVs. its portion monetary value would resile back. Thus the recommendation is to keep.