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three theories of Dividends

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You are a controller or a CFO of DuPont Corporation and you have two major decision:

1. You determine the capital structure of your company; therefore you must compare the two theories of capital structure and determine what mix of capital structure your company.

2. Your second decision the recession has hit your company "hard" and limited the company's cash. The company has long standing policy of paying cash dividends. You must discuss the pro and con of dividends and to some other form of payout plan. Also discuss the three theories of Dividends: Irrelevance theory, Bird in the hand theory, and tax preference theory.

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1. You determine the capital structure of your company; therefore you must compare the two theories of capital structure and determine what mix of capital structure your company.

One theory of capital structure is that companies have an optimal capital structure is based on a trade-off between the benefit and costs of using debt. From this perspective, the benefits of using debt are that the management does not lose control of the company, and in addition, the company can deduct interest from income before taxes. It saves taxes. On the other hand there is a financial risk in going in for debt.

The second theory that CFO of DuPont Corporation must consider is the pecking order theory that suggest that companies follow a hierarchical pattern in which internal funds are preferred to external funds, and borrowing is preferred to issuing risky securities.

According ...

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This explanation provides you a comprehensive argument relating to three theories of Dividends

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See Also This Related BrainMass Solution

Dividend Theory

Based on what you know about dividend theory, evaluate the correctness of each of the following statements:
- a. If the dividend irrelevance theory (which is associated with Modigliani and Miller) were exactly correct, and if this theory could be tested with good data, then we would find in a regression of dividend yield and capital gains, a line with a slope of -1.0.
- b.The tax preference and bird-in-the-hand theories lead to identical conclusions as to the optimal dividend policy.
- c.If a company raises its dividend by an unexpectedly large amount, the announcement of this new and higher dividend is generally accompanied by an increase in the stock price. This is consistent with the bird-in-the-hand theory, and Modigliani and Miller used these findings to support their position on dividend theory.
- d. If it could be demonstrated that a clientele effect exists, this would suggest that firms could alter their dividend payment policies from year to year to take advantage of investment opportunities without having to worry about the effects of changing dividends on capital costs.

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