Problem memorising? Blog it
Been studying Finance abit lately. Uhh...only abit lah and finding some difficulty remembering some points. Exam is around the corner. Can I remember the theories and important points if I blog it here??? Let me try.
Question:
What are the failings of IRR as an investment appraisal technique and discuss any ways that these failings can be overcome. (6 marks)
Answer:
There are a number of drawbacks to the use of IRR.
More than one change in the CF sign => lead to multiple IRR.
If final CF is -ve => lead to 2 IRRs.
Difficult to indicate the better of 2 mutually exclusive projects.
IRR is a percentage return, not an absolute measure of wealth.
How to overcome, use incremental CF.
Question:
Identify 4 mkt frictions & discuss how they affect the dividend decision. (9 marks)
4 mkt frictions - taxes, transaction costs, floatation costs & information costs.
Answer:
If taxes are high on income but lower on capital, companies would have an incentive to pay out very low dividends & allow investors to make their capital gains. Taxes would also influence whether companies engage in share repurchase, this might have less of a tax on them (good way to return cash to s/h).
If there were no transaction costs (and assume no taxes) then investors would be indifferent between div and cap gains. If it costs $25 every time they sell shares to raise money, they will be reluctant to do this, favouring higher div paying companies.
Flotation costs - if companies could raise cash from cap mkt w/o any fees or costs, they could pay out all earnings as div. They could raise new money at no cost. However, there are flotation costs so companies will build a reserve of retained earnings that they can use as a source of cap.
Info costs - companies are constrained on what they can tell investors so there is no free flow of info between companied and investors. Company will favour a dividend policy that is stable and predictable which they can use the div to signal info to investors.
Question:
Some companies pay share dividends instead of cash dividends to shareholders. What are the advantages & disadvantages of these as far as the
a> company is concerned,
b> shareholder is concerned? (6 marks)
Answer:
The share dividen is sometimes known as scrip dividend. For the co, it means that instead of paying out $50m in cash as dividend, it is paying out $50m in shares as dividend. The obvious benefit to the co is that it saves CF. Drawback is there are more share in issue, which may lead to higher dividen payments in future & also pressure on the earnings per share figure.
For the s/holders, the benefit is they have a larger shareholding in the co than b4. They do not get any cash & if the scrip goes to all s/holders, then they do not have any percentage increase in their stake in the company.
Question:
Discuss the agency concerns surrounding the dividend payment. (6 marks)
Answer:
The agency problems surrounding dividend payment center on companies where maybe things are not going as well as expected. Payment of dividend represents cash leaving the company. If the company has debt outstanding, the debtholders have first claim on the assets if there are problems. By paying a cash dividend to shareholders, mgrs are potentially shifting cash away from bondholders to shareholders. In many cases, there will be covenants in bond contracts preventing companied from paying dividends if certain levels of financial performance are not maintained.
Question:
What are the failings of IRR as an investment appraisal technique and discuss any ways that these failings can be overcome. (6 marks)
Answer:
There are a number of drawbacks to the use of IRR.
More than one change in the CF sign => lead to multiple IRR.
If final CF is -ve => lead to 2 IRRs.
Difficult to indicate the better of 2 mutually exclusive projects.
IRR is a percentage return, not an absolute measure of wealth.
How to overcome, use incremental CF.
Question:
Identify 4 mkt frictions & discuss how they affect the dividend decision. (9 marks)
4 mkt frictions - taxes, transaction costs, floatation costs & information costs.
Answer:
If taxes are high on income but lower on capital, companies would have an incentive to pay out very low dividends & allow investors to make their capital gains. Taxes would also influence whether companies engage in share repurchase, this might have less of a tax on them (good way to return cash to s/h).
If there were no transaction costs (and assume no taxes) then investors would be indifferent between div and cap gains. If it costs $25 every time they sell shares to raise money, they will be reluctant to do this, favouring higher div paying companies.
Flotation costs - if companies could raise cash from cap mkt w/o any fees or costs, they could pay out all earnings as div. They could raise new money at no cost. However, there are flotation costs so companies will build a reserve of retained earnings that they can use as a source of cap.
Info costs - companies are constrained on what they can tell investors so there is no free flow of info between companied and investors. Company will favour a dividend policy that is stable and predictable which they can use the div to signal info to investors.
Question:
Some companies pay share dividends instead of cash dividends to shareholders. What are the advantages & disadvantages of these as far as the
a> company is concerned,
b> shareholder is concerned? (6 marks)
Answer:
The share dividen is sometimes known as scrip dividend. For the co, it means that instead of paying out $50m in cash as dividend, it is paying out $50m in shares as dividend. The obvious benefit to the co is that it saves CF. Drawback is there are more share in issue, which may lead to higher dividen payments in future & also pressure on the earnings per share figure.
For the s/holders, the benefit is they have a larger shareholding in the co than b4. They do not get any cash & if the scrip goes to all s/holders, then they do not have any percentage increase in their stake in the company.
Question:
Discuss the agency concerns surrounding the dividend payment. (6 marks)
Answer:
The agency problems surrounding dividend payment center on companies where maybe things are not going as well as expected. Payment of dividend represents cash leaving the company. If the company has debt outstanding, the debtholders have first claim on the assets if there are problems. By paying a cash dividend to shareholders, mgrs are potentially shifting cash away from bondholders to shareholders. In many cases, there will be covenants in bond contracts preventing companied from paying dividends if certain levels of financial performance are not maintained.
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