BUSF_A01.qxd

Problems

lDebt finance – relatively cheap.

lTends to favour low dividends where business needs funds for investment.

lAgency problem – the best interests of shareholders may favour a large divi-

dend (no positive NPV investment opportunities), but the directors may pre-

fer to retain the funds and invest despite this.

lShare repurchase increasingly a popular alternative to dividend payments,

but with much the same effect.

Most business finance texts deal with the question of dividends and dividend policy. Both

Arnold (2005) and Brealey, Myers and Allen (2007) contain interesting sections on it. Emery,

Finnerty and Stowe (2007) discuss this topic in a practical and interesting way.

Further reading

Further reading

12.1 According to MM, what is the difference between the value of a dividend received

now and one received in the future, if the shareholders are indifferent as to whether

they receive the dividend now or in the future?

12.2 According to MM, what rule should a business follow in paying dividends to its

shareholders?

12.3 What are ‘homemade dividends’ in the context of MM? Why might a shareholder want

such a dividend?

12.4 What, in outline, is the traditional view on the payment of dividends?

12.5 Why is the MM position on dividends partly dependent on their assumption of no taxes?

12.6 Why should we find that businesses attract a ‘clientele’ of shareholders as a result of

their dividend policy?

Review questions

Suggested answers to

Review questions

in Appendix 3.

(Problems 12.1 to 12.5 are basic-level problems, whereas problems 12.6 to 12.9 are

more advanced and may contain some practical complications.)

12.1*The shareholders of Distributors plc have an opportunity cost of capital of 20 per cent.

The business makes a steady profit of £25 million each year, which is all paid out as

a dividend. The opportunity has arisen to invest the dividend that is about to be paid

(£25 million). This investment will give rise to a single payoff in three years’ time. The

normal £25 million dividend will be paid next year and subsequently, in the normal way.

What dividend needs to be paid in three years’ time so that the shareholders will be

equally content to wait the three years, adopting the Modigliani and Miller assumptions

on dividends?

PROBLEMS

Sample answers to
problems marked with
an asterisk appear in
Appendix 4.

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