Dividends in General
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Dividends have been in the news often due to the fact that government would provide tax benefits to dividend paying companies. Technology companies typically pay low or no dividends since they reinvest cash flows in research and development to fund future growth. However, as many technology companies mature (e.g. Microsoft, Dell, Cisco, Oracle, Intel) and build large cash balances, these companies may begin to develop a policy of paying dividends. The new tax benefits make such a policy even more attractive.
1. Why is the government considering a tax cut on dividends in general?
2. What typically happens to a firm's value when it increases its dividend?
3. What would you expect to happen for a high-tech firm such as Microsoft?
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The solution discusses why the government is consider a tax cut on dividends in general and what happens typically to a firm's value when it increases its dividend.
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1. Why is the government considering a tax cut on dividends in general?
In 2003, the government signed into law the Jobs and Growth Tax Relief Reconciliation Act of 2003 (JA GTRRA) which "lowered the federal individual tax rate on dividends from the top ordinary income tax rate of 38.6% at the time to the long-term capital gains tax rate of 15%" (Gadarowski, Meric, Welsh, & Meric, 2007, p. 89). Given this law, the issue on double taxation of corporations and their shareholders particularly on dividends became less important. In this regard, stockholders of corporations sitting on large piles of cash will ...
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