Southeastern Steel Comp

Southeastern Steel Company

A.

1. What is meant by the term DIVIDEND POLICY?

Dividend policy is defined as the firm’s policy with regard to paying out earnings as dividend versus retaining them for reinvestment in the firm.

2. Explain briefly the dividend irrelevance theory that was put forward by Modigliani and Miller. What were the key assumptions underlying their theory?

Dividend Irrelevance theory according to Modigliani and Miller stated that dividend policy has no effect on either the price of a firm’s stock or its cost of capital. In other words, the value of the firm depends only on the income produced by its assets.

The assumptions are: among other things, that no taxes are paid on dividends, that stocks can be bought and sold with no transactions costs, and that everyone has the same information regarding the firms’ future earnings. Also, MM argued that that each shareholder can construct his or her own dividend policy. In conclusion of MM’s dividend irrelevance theory is that dividend policy does not affect stock prices or the required rate of return on equity.

3. Why do some investors prefer high-dividend-paying stocks, while other investors prefer stocks that pay low or nonexistent dividends?

Investors might prefer dividends to capital gains because they may regard dividend as less risky than potential future capital gains. Investors would value high pay out firms more highly that is, a high-payout stock would have a high price.

Investors might prefer low-payout firms or capital gains to dividends because they want to avoid transaction costs- that have to reinvest the dividends and incurring brokerage costs and taxes. In addition, if an investor holds a stock until his/her death, the beneficiaries can use the date of the death as the costs-basis date and escape all previously accrued capital gains.

B.

Discuss (1) the information content, or signaling, hypothesis; (2) the clientele effect; and (3) their effects on dividend policy....