Discuss the relationships between operating, financial and combined leverage? Does the firm use financial leverage if preferred stock is present in its capital structure? What type of effect occurs when the firm uses operating leverage?
We learned that Apple Computer (AAPL) recently reinstated the payment of cash dividends, which had been suspended since the 1990s. What are some reasons that might have influenced the firm's decision to begin paying dividends again?
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First, operating leverage is the ratio between the fixed costs of the total production costs to the variable component of the total production costs. The higher this value is the higher is the company's operating leverage. Financial leverage is total debt divided by the company's stockholders' equity. Combined leverage is the percentage change in earnings per share of a company divided by its operating leverage.
Capital structure and dividend policy relationship is discussed.
Residual Dividend Policy and Borrowing Money to Pay Dividends
A) Discuss the pros and cons of having the directors' formally announce what a firm's dividend policy will be in the future.
B) Would it ever be rational for a firm to borrow money in order to pay dividends? Why or why not?
C) One position expressed in the financial literature is that firms set their dividends as a residual after using income to support new investments.
i. Explain what a residual dividend policy implies, illustrating your answer with a table showing how different investment opportunities could lead to different dividend payout ratios.
ii. Where we considered the relationship between capital structure and the cost of capital. If the WACC-versus-debt-ratio plot were shaped like a sharp V, would this have a different implication for the importance of setting dividends according to the residual policy than if the plot were shaped like a shallow bowl (or a flattened U)?