Amounts of Equity and Debt Example for Free

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There are various types of equity and debt that constitute a capital structure. Typically, the components that make up these two asset classes are bonds, preferred stock, and common stock. It also explains the financing methods it has used to conduct growth initiatives such as research and development or acquiring assets.

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A dividend is money paid directly to an investor in a company’s stock. There are certain publicly owned companies which offer a dividend with their stock, when on the other hand some others do not. Dividend, in simple terms, is the profit after-tax distributed to common man by the Board of Directors of a corporation. Every company has to decide its dividend per share based on a simple formula. That takes the total dividend payment and divides it by the total number of outstanding shares. For e.g. if a company has 5 million shares outstanding, and it decides to distribute 10 million dollars to its shareholders; hence the dividend per share is $2 (10 million dollars divided by five million shares). A dividend policy is a set of company rules and guidelines used to decide how much the company will pay out to its shareholders.


There are seven factors affecting Dividend Policy: Legal constraints Internal constraints Growth prospects Owner considerations Market considerations Source: Dividend Policy.pdf


Investment Opportunities A firm with more investment opportunities will pay a lower fraction of its earnings as dividends than a stable firm. Stability earnings A firm with more stable earnings will pay out a higher fraction of its earnings as dividends than a firm with variable earnings. Alternative sources of capital A firm which can issue new stock or bonds at low cost (such as underwriting commissions) will be more likely to have a high dividend payout ratio. Constraints Firms which have borrowed large amounts of debt usually have several constraints on their dividend policy and will therefore follow more conservative dividend policies. Signalling incentives Firms which are undervalued may use dividend increases as signals to the markets. Stockholder characteristics Firms may have acquired a reputation as high dividend yield firms also acquire stockholders who desire high dividends. Consequently, they cannot suddently shift policy.


One of the main reasons as to why shareholders observe companies is to check their capabilities in order to initiate a dividend. As mentioned earlier, dividends are those after-profit payments that a company makes to its shareholders. However, when a company offers a dividend to its stock holders, it is taking money that could be reinvested into the company, and distributing it to shareholders as a benefit of investing in the company. Hence, it is not considered a business expense. The significance of a dividend policy in a company’s stock value has always been proposed to be high. However, more scholars are suggesting that corporate dividend policies do not matter and should not matter in a company’s stock value. The reason for this tiff of arguments initiated from the fact that investors can create their own dividends on other investment options. A wise investor can even look at more stable bonds to earn a return on investment rather than a dividend policy that is subject to change. Also, the earning from dividends is taxed higher as compared to capital gains. Source: Financial features of dividend paying firms in the hospitality industry As for those who value profit certainty of a company, a sound dividend policy is important. The basis being that a high and regular corporate dividend policy means that the company has a benchmark for doing well. Thus, more dividends can equate to the overall health of the company.


A significant amount of research has been conducted in the past debating if and how dividend payment matters in terms of firm value. Gordon, 1959 believe that dividend payout increases shareholder’s wealth. Whereas Litzenberger and Ramaswamy, 1979, argue that dividend payout may decrease shareholder’s wealth. On the other hand, Miller and Scholes, 1978, posit that the amount of dividends is irrelevant to firm value. Source: Financial features of dividend paying firms in the hospitality industry Under some strict conditions, the dividend payment does not matter in terms of firm value. Paying small dividends or even paying no dividends should not affect firm value. As shown by Millet and Modigliani (1961), assuming that it’s a perfect capital market, paying an extra dollar per share in dividends is offset by an exact one-dollar decline in the stock price. In essence, firm value is solely determined by the net present value (NPV) of investment decisions. As long as the net cash flows from a firm’s investment decisions remain constant, the value of the firm should not be affected regardless of whether the cash flows are distributed or retained.


Arguments against Dividend Policy Some Financial analysts around the globe consider dividend policy to be irrelevant since investors have the ability to create “homemade” dividends. These analysts believe that this income is achieved by individuals moulding their personal portfolios as such to reflect their own predilections. For e.g., those investors seeking a steady stream of income are more likely to invest in bonds; since the interest payments don’t charge. These investors would rather not be interested in dividend-paying stock, due to the fluctuation of value. For this reason, persons who own bonds will lose interest in any company’s dividend policy as their personal interest payments won’t change. Another argument claims that little to no dividend payout is more favourable for investors. Reason being that taxation on a dividend is higher than on a capital gain. The argument against dividends is based on the belief that a firm that reinvents funds (rather than paying them out as dividends) will increase the value of the firm as a whole and hence also increase the market value of the stock. As claimed by the supporters of the no-dividend-policy, a company’s alternatives to paying out excess cash ad dividends are: Acquiring new companies and profitable assets Repurchasing the company’s own shares Undertaking more projects Reinvesting in financial assets Arguments for Dividends In resistance to the two arguments mentioned above is the proposal that a high dividend payout would prove to be much more beneficial for investors since dividends provide certainty about the company’s financial security. Another reason as to why dividends cause interest among investors is because they secure current income. There are also many examples of how the decrease and increase of a dividend distribution can affect the price of a security. Companies that have a long-standing history of steady dividend payouts would negatively affected as compared to one with unsteady dividend payouts. They can, however, be positively affected simply by increasing their dividend payouts or making additional payouts of the same dividends. Additionally, from the eyes of the investor, companies without a dividend history are viewed favourably when they declare new dividends


The three main theories of Dividend Policy are as follows: Dividend Irrelevance Theory Modigliani and Miller theorised that, without taxes or bankruptcy costs, dividend policy is also irrelevant. This is known as the “Dividend Irrelevance Theory”, pointing out that dividends do not affect a company’s capital structure, or its stock price. According to MM irrelevance theory, the division of a firm’s earnings between dividend payments to shareholders and internal retentions does not matter to a very large extent. Modigliani and Miller claim that managers need not validate over the optimal dividend policy, since one does not exist. Their theory also states that investors can affect their return on a stock irrespective of the stock’s dividend. MM built this theory on a range of key assumptions, to simplify the analysis: It is rational for the existence of perfect capital markets and all investors in it. There are no taxes. On the other hand, the tax rates applicable to dividends and capital gains do not differ. Every firm has its own specified investment policy, unchangeable. It means that the business risk complexion of the firm will not change if the financing of new investments is made out of retained earnings. Bird-in-the-Hand Theory This theory, introduced by Jon Litner (1962) and Myron Gordon (1963), states that dividends are relevant. The fundamental nature of the Bird-in-the-Hand Theory is that shareholders are not willing to take risks and prefer to stay safe by receiving dividend payments, rather than future capital gains. Shareholders believe that dividend payments are more promising as compared to future capital gains. Hence, “bird in the hand is worth more than two in the bush”, wherein the bird refers to dividends and the bush to capital gains. Gordon proposed that investors have a certain preference for a fixed level of income rather than the prospect of a higher, albeit less certain, income at some time in the future. Tax Preference Theory Taxes are important considerations for investors. There are three ways in which taxes affect the dividend preferences of shareholders: For individual investors, tax rates differ for dividends and capital gains Taxes on capital gains are not due until the stock is sold. If the stock is held until the shareholder expires, no tax is due at all. As mentioned earlier, capital gains are taxed at a lower rate than dividends. This is the reason as to why investors may prefer capital gains to dividends – the safety. Furthermore, investors do have the supremacy when capital gains are realised; however, they don’t have it in the case of dividend payments, over which the related company has control.

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Amounts Of Equity And Debt Example For Free. (2017, Jun 26). Retrieved January 29, 2023 , from

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