Corporate Finance (Essay Sample)

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Corporate Finance
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Corporate Finance
In corporate finance, dividend policies may change depending on several factors such as market conditions and economic situation. Mullin Plc. has not paid dividends for the past five years, 2008-2012. Previously it paid a constant annual dividend of five percent per share, 2003-2007. My aim in this paper is to evaluate critically the dividend policy options available to Mullin Plc., given the present and future economic situations.
According to Berk and DeMarzo (2011), a company needs only to pay dividends when it is unable to reinvest its cash at a higher rate than the business owners would do with the same amount of money. Where Mullin Plc. earns highly on equity, for example, 28%, and bears no debts it should not pay out the dividends but instead retain and re-invest the returns. Sources indicate, "If a company pays out dividends, but an investor would prefer the money to be re-invested, then the investor can simply use the dividends to buy more shares" (Borowski 2010, p.8). The British economy is on a recovery trend, projecting a growth in GDP from 1.3% to 1.9% in 2013 and unemployment rates expected to fall to 7.5% in Quarter 3 of 2014 (British Chamber of Commerce 2013). This shows that businesses are recovering hence creating confidence in the investors. According to literature, Mullin Plc. should hold back payout of dividends for business growth, due to this confidence (Clayman et al. 2008).
Currently corporations include issues of paying out dividends in the form of repurchasing of shares, or increasing the investors’ shares. Previously payouts involved cash transactions only, with decisions lying squarely with the management, creating a collision of interests with shareholders (Ross et al. 2008). Mullin Plc. can thus also increase investor shares in order to maintain its cash ratio.
Taxes affect dividend payouts (Werner and Stoner 2011). Literature indicates, "income taxes on investors who receive dividends payments are likely to reduce the demand for dividends and thus prompt corporations to retain a larger share of their profits" (Baker 2009, p.135). In this case, if Mullin Plc. is earning, for example, 10% on returns while the investors only expect that much, it should keep all the returns due to tax consequences. In addition, "high-growth firms with great investment opportunities do not usually pay out dividends," (Damodaran 2010, p.514). Consider a company earning 10% on its equity on a consistent basis making £100,000 in profits. Re-investing this amount, investors expect the company will make £ 10,000. If instead the company pays the £100,000 to the shareholders in terms of cash dividends, the investors’ will face taxation. Miller and Oats (2012) indicate the result is a reduced amount of profit margin resulting from the summation of individual tax deductions. To expound, if 30% is the average tax rate for the individual investors; this translates to £30,000 in taxation on the profit alone, leaving only £70,000. Upon re-investing at 10%, this gives the investors a maximum return of £7,000; that is 10% of £70,000. Literature shows that such a trend when extrapolated over time sums up to substantial figures (Drury 2008).
In conclusion, share price awarded to investors is a risk especially to those who own ordinary shares due to volatility of their investments. Given the current high recession recovery rate of the UK economy and projected future growth, investors have confidence. For this reason, they are comfortable with continuous re-investment of the profits to make more money. To them this is a better option since they posit better return outcomes. In the case of Mullin Plc., the best dividend policy is to keep the returns and con...