Impact of Taxation on Dividends

Impact of Taxation on Dividends Abstract: This research paper attempts to analyze the different tax systems and their impact on the dividend distributions. It is explained that the dividend payout is monotonically distributed across tax regimes as the firms in double taxation (classical) system have significantly lower payouts than companies in the partial-imputation system, while companies in the full imputation system pay the highest payouts. Our results hold when the other fundamental determinants of dividends are held through Lintnerà ¢Ã¢â€š ¬Ã¢â€ž ¢s model and the actual payout ratio. Overall, it is reported that the type of dividend tax system affect the dividend payout. Introduction: The tax burden on dividends depends on corporate and personal income tax systems. In a classical system, the total tax is the sum of the corporation tax, the effective capital gains tax and the tax on dividends. Typically the tax on dividends exceeds the gains tax creating an incentive to reduce dividends. In an imputation system on the other hand, the total tax is given by the corporation tax plus the effective gains tax plus the reduced dividend tax. If the reduction in the tax on dividend is large enough to make reduced tax dividend lower than the effective capital gains tax, an incentive to increase dividends is created. Understanding the impact of taxes on dividend policy is important for both academicians and practitioners. From academic perspective, the relevance of taxation will highlight the extent to which companies consider the after tax return of their shareholders and how any tax reform will affect the firmà ¢Ã¢â€š ¬Ã¢â€ž ¢s dividend payouts. For practitioners, knowing how taxation affects dividends is also of considerable interest. Since shareholders are taxed differently, if stock prices reflect the tax status of one particular group of investors, other groups can take advantage of these differences by, namely trading around the ex-dividend dates to capture/avoid dividends. Moreover, understanding the impact of dividend taxation will be important for fund managers and analysts as changes in tax codes could affect the net returns and the relative pricing of securities. Most countries around the world adopt different systems of taxing dividends. Some follow a classical tax system where corporate income is treated differently from personal income in terms of statutory tax rate and deduction rules, others use some level of integration between corporate and personal income. The important distinction between these two different systems is the taxation of dividends. Countries that follow the classical system separate shareholders income from the income of their corporations. As a result the same unit of earning in the company is taxed twice when it is paid as dividend: first at the corporate level and then at the personal level; a disadvantage known as à ¢Ã¢â€š ¬Ã…“double taxationà ¢Ã¢â€š ¬?. In contrast, countries that follow a more integrated system usually have a full or partial relieve from dividend tax in consideration of the fact that the same unit of earning has been taxed at the corporate level. In Pakistan, the system of double taxation (cla ssical system) is implemented i.e. the dividends are taxed on corporate level and then the same unit of earning is taxed at shareholder level. Background More than forty years ago, Miller and Modigliani (1961) showed that, after some assumptions, such as complete and perfect capital markets, a firmà ¢Ã¢â€š ¬Ã¢â€ž ¢s dividend policy does not affect its value. While this theory has highlighted the five main factors that could affect dividends, namely signalling, agency costs, behavioral (catering and mental accounting) and taxation, the empirical evidence provided to-date on such effects is mixed, (Allen and Michaely (2006) and Graham (2003). In particular, while in theory taxation is expected to prevent companies from paying dividends, most previous empirical studies have shown that taxation plays a minor role in dividend decision (e.g. Brav et al., (2005), Fama and French (2001), Julio and Ikenberry (2005). Therefore it is not clear why companies still pay dividends despite their heavy tax burden. In this paper, the dividend tax systems is analyzed and test the hypotheses that, in countries where the tax burden on dividends is high, companies pay low dividends. Although dividends may have a tax disadvantage, previous studies show that shareholders react positively to dividend increases and negatively to dividend decreases (e.g. Michealy, Thaley and Womack (1995). Long (1978) provides evidence that in dual class shares, investors favor cash dividend over stock dividend stocks. The tax disadvantage of dividends and yet their popularity challenges the traditional policy of payout policy. Blackà ¢Ã¢â€š ¬Ã¢â€ž ¢s (1976) dividend puzzle discusses the weaknesses of the finance theory in answering the simple question, why firms subject to a classical tax system to pay dividends? Some studies explain dividends away from taxes. For example Lintner (1956) in his classical study, shows that firms adopt a subjective target payout policy by decreasing dividends very slowly and hardly ever cut them. Models based on information asymmetry suggest that dividend changes provide information about the firmà ¢Ã¢â€š ¬Ã¢â€ž ¢s future cash flows (Bhattacharya (19 79) and Miller and Rock (1985) or about the firmà ¢Ã¢â€š ¬Ã¢â€ž ¢s cost of capital and/or maturity stage (Grullon, Michaely and Swaminathon (2002), Grullon and Michaely (2000). From the agency theory perspective, dividends provide a disciplining tool to reduce agency costs (Easterbrook (1984) and Jensen (1986). Behavioral finance theory suggests that dividends are paid in part to accommodate certain biases in individuals such as market sentiment (Baker and Wurgler (2004) or self control, mental accounting and regret avoidance (Shefrin and Statman (1984). Taxation moel suggests that if dividends are taxed at a higher rate than capital gains, firms should prefer to retain earnings or buy back shares (e.g. Auerbach (1979), Bradford (1981) , Auerbach and Hasset (2003), Lasfer (1996). Literature Review: To assess the impact of dividend tax on investment and financial policy of the firm, the literature has followed three basic approaches. The first approach is to examine the relation between the risk-adjusted pretax rate of return and dividend yield. If dividend tax is relevant and if dividends are taxed at a higher rate than capital gain, than pretax return should increase in proportion to dividend yield to compensate for dividend tax disadvantage. Black and Scholes (1974), Gordon and Bradford (1980), and Miller and Scholes (1982) did not find evidence that the tax differential between dividends and capital gain have an impact on pretax returns, while Lintzenburger and Ramaswamy (1979) find evidence to the contrary. The second approach is to examine the ex-dividend behavior of stock prices. Absent dividend tax, the value of a stock should fall by the full amount of the dividend on the ex-dividend day. Elton and Gruber (1970) provide evidence that US stock prices fall by less than th e full amount of the dividends on the ex-dividend day. Poterba and Summers (1985) and Lasfer (1996) show similar results. Other studies did not find evidence that the tax differential between dividends and capital gains have an impact on the ex-dividend behavior, for example, Hearth and Rimbey (1993), Lakonishok and Vermaelen (1983). The third approach is to employ event study analysis. Changes in tax laws provide a natural experiment for investigating the impact of dividend tax on investment and financial decision. Poterba and Summers (1985) show that higher dividend tax is associated with lower investment and dividends. Poterba (2004) study shows that the tax disadvantage relative to capital gains has a negative effect on dividend payment. Blouin et al. (2004) study the impact of the 2003 tax reduction in the US and find dramatic increase in the regular dividends and the special dividends after enactment and a decline in the share repurchases. Chetty and Saez (2004) report on incr ease in the fraction of dividend payers following the 2003 dividend tax reduction. In Pakistan the system of double taxation is implemented on dividends, its comparison with countries implying other system of taxations is studied. Objectives: The objectives of this research paper are to find out the impact of taxation on dividend policy and its impact on the financial and investment decision of the firms. Research Question: Is the dividend payout ratio of firms in full or partial integration system higher than the dividend payout ratio of firms in double taxation system? Theoretical Framework: Dividend Payout Taxation (Independent Variable) (Independent Variable) (Dependent Variable) Hypotheses: H1: Dividend payout ratio is higher in full and partial integration systems than in classical system of taxation. H2: Dividend payout ratio is NOT higher in full and partial integration systems than in classical system of taxation. Hypotheses Testing: Unlike the full integration system, the classical system carries with it a disadvantage of double taxation. If tax on dividends has an impact on the financial policy of the firm, then firms in classical system will lower or avoid dividends as much as they can, while firms in full integration systems will not have to lower their dividends. Thus the hypothesis H1 is expected to be true. System No. of Firm Observations Net Tax Rate on Dividend (%)* Payout Ratio =DPS/EPS* Classical System 18 50% 0.32 Partial 15 42% 0.45 Full 17 35% 0.47 * = Subject to 10% level of significance Research Methodology: Population: Population includes observations that have been collected randomly from firms in 6 countries representing all the three types of taxation systems. Sample: It includes 50 observations, i.e. data has been collected randomly from 50 firms representing all the three taxation systems. Sources of Data Collection: The annual OECD tax database Corporate and Individual Taxes, A Worldwide Summary, Price Waterhouse Conclusions: The dividend payout policy of companies was analyzed that applies different tax systems with regard to dividends. It is found that companies located in countries that apply double taxation system (classical tax system) to have less dividend payout than do companies located in countries that try to partially avoid double taxation. In general, tax effect measured by the type of dividend tax treatment has a strong effect on the size of dividend payout.

Term Paper of Dbbl

Introduction: To finance their investments firms use retained earnings, new borrowings or the issue of stock. The financing decision involves i) dividend and ii) the capital structure. Dividend policy involves the decision to pay out earnings versus retaining them for reinvestment in the firm, and dividend policy decisions can have either favorable or unfavorable effects on the price of a firm’s stock. Cash distributions are made to stockholders form the firm’s earnings, whether those earnings were generated in the current period or in previous periods. Origin of the Report:During this semester of Summer 2010 in MBA program of East West University, we are required to submit a term paper in the course Corporate Finance: â€Å"An Appraisal of Dividend Policy and Capital Structure of An Organization†. We have chosen PRAN for our term project. Objectives of the Report: The general objective is to prepare and submit the term project within specified time by having an idea and over viewing the PRAN, their Dividend Policy and their Capital Structure. Scope of the Report: The scope is limited to over viewing PRAN their dividend policy and the Capital Structure they have adopted for their organization.Limitations of the Study: Secondary data were used in this study as result it may differ from actual data. As a group, we have also faced some difficulties in compiling and discussing it due to unavailability of all members at the same time. The absence of solid and verse knowledge about dividend policy is absent and we have taken it as an addition in our learning curve. Methodology: The report is originated from secondary data sources- 1. The Company’s Annual Report 2. DES website 3. Different Articles from Internet 4. Other related websitesCompany Profile PRAN: PRAN stands for Programme for Rural Advancement Nationally. â€Å"PRAN† is currently the most well known household name among the millions of people in Bangladesh and abroad also . Since its inception in 1980, PRAN Group has grown up in stature and became the largest fruit and vegetable processor in Bangladesh. It also has the distinction of achieving prestigious certificate like ISO 9001:2000, and being the largest exporter of processed agro products with compliance of HALAL & HACCP to more than 70 countries from Bangladesh.PRAN is the pioneer in Bangladesh to be involved in contract farming and procures raw material directly from the farmers and processes through state of the art machinery at our several factories into hygienically packed food and drinks products. The brand â€Å"PRAN† has established itself in every category of food and beverage industry and can boost a product range from Juices, Carbonated Drinks, Confectionery, Snacks, and Spices to even Dairy products.Today, our consumers not only value â€Å"PRAN† for its authentic refreshing juice drinks products, but also for its mouth watering quality confectionery products with high visual appeal and exciting texture. We intend to expand our presence to every corner of the world and strive to make â€Å"PRAN† a truly international brand to be recognized globally. The authorized capital of PRAN is BDT 50,000,000 and paid up capital is BDT 8,000,000. The proportion is given below: |Share Percentage | |Director /Sponsor |Govt. Institute |Foreign |Public | |42. 75% |0% |1. 27% |0% |55. 98% | [pic] Dividends: Dividend is that part of the profits of a company which is distributed amongst its shareholders. According to ICAI, â€Å"Dividend is a distribution to shareholders out of profits or reserves available for this purpose. † In other words we can say that a corporation makes Dividend payments to its shareholder. It is the portion of corporate profits paid out to its stockholders.When a corporation earns a profit at the end of a financial year, that profit can be uses by two different ways: it can either be re-invested in the business or it can be pai d to the shareholders as a dividend. Many corporations retain a portion of their earnings and pay the remainder as a dividend. Dividend Policy and Stock Value: There are various theories that try to explain the relationship of a firm's dividend policy and common stock value. Dividend policy is the policy a company uses to decide how much it will pay out to shareholders in dividends. A firm has different options to deal with its earnings.It can give all their earnings as dividend or it can retain all its earnings as retained earnings. The firm can also declare a portion of its earnings as dividend and can retain other portion as retained earnings. Dividends may be in the form of cash or stock. Most secure and stable companies offer dividends to their stockholders. Their share prices might not move much, but the dividend attempts to make up for this. High-growth companies  rarely offer dividends because all of their profits are reinvested to help sustain  higher-than-average  gr owth. Dividend Relevance Theory:The value of a firm is affected by its dividend policy – the optimal dividend policy is the one that maximize the firm’s value. Optimal Dividend Policy: Proponents believe that there is a dividend policy that strikes a balance between current dividends and future growth that maximizes the firm's stock price. Dividend Irrelevance Theory: The theory states that a firm’s dividend policy has no effect on either its value or its cost of capital. Bird-in-the-Hand Theory: It states that dividends are relevant. Remember that total return (k) is equal to dividend yield plus capital gains.Myron Gordon and John Linter took this equation and assumed that k would decrease as a company's payout increased. As such, as a company increases its payout ratio, investors become concerned that the company's future capital gains will dissipate since the retained earnings that the company reinvests into the business will be less. Gordon and Linter argued that investors value dividends more than capital gains when making decisions related to stocks. In this theory â€Å"the bird in the hand' is referring to dividends and â€Å"the bush† is referring to capital gains.The traditional argument in favour of dividend is the idea that dividends reduce risk because they bring shareholders’ cash inflows forward. Although shareholders can create their own dividends by selling part of their holdings, this entails trading costs, which are saved when the firm pays dividends. The risk reduction or bird in the hand argument is associated with Graham and Dodd (1951) and with Gordon (1959) and it is often defended as follows. By paying dividends the firm brings forward cash inflows to shareholders, thereby reducing the uncertainty associated with future cash flows.In terms of the discounted dividend equation of firm value, the idea is that the required rate of return demanded by investors (the discount rate) increases with the plough -back ratio. Although the increased earnings retention brings about higher expected future dividend, this additional dividend stream is more than offset by the increase in the discount rate. This argument overlooks the fact that the risk of the firm is determined by its investment decisions and not by how these are financed.The required rate of return is influenced by the risk of the investments and should not change if these are financed from retained earnings rather than from the proceeds of new equity issues. As noted by Easterbrook (1984), in spite of paying dividends the firm does not withdraw from risky investments, thus the risk is merely transferred to new investors. Reasons for Paying Dividends: 1. Clientele Effect: The investors in your company like dividends. 2. The Signaling Story: Dividends can be signals to the market that you believe that you have good cash flow prospects in the future. 3.The Wealth Appropriation Story: Dividends are one way of transferring wealth fro m lenders to equity investors (this is good for equity investors but bad for lenders) Types of Dividend Policies: 1. Constant-Payout-Ratio: Constant-Payout-Ratio is a dividend policy based on the payment of a certain percentage of earnings to owners in each dividend period. The problem with this policy is that if the firm’s earnings drop or if a loss occur, the dividend may low or nonexistent. 2. Regular Dividend Policy: Regular Dividend Policy is a dividend policy based on the payment of fixed amount of dividend in each period.It provides the owners with positive information, thereby minimizing their uncertainty. 3. Low Regular and Extra Dividend Policy: Low regular and Extra Dividend Policy refers to a dividend policy based on paying low regular dividend, supplemented by additional dividend when earnings are higher than normal in a given period. Nature of Dividend Decision The dividend decision of the firm is crucial for the finance manager because it determines: 1. The amo unt of profit to be distributed among the shareholders, and 2. The amount of profit to be retained in the firm. There is a reciprocal relationship between cash dividends and retained earnings.While taking the dividend decision the management take into account the effect of the decision on the maximization of shareholders' wealth. Maximizing the market value of shares is the objective. Dividend pay out or retention is guided by this objective. Factors Affecting Dividend Policy: A. External Factors B. Internal Factors A. External Factors Affecting Dividend Policy 1. General State of Economy: In case of uncertain economic and business conditions, the management may like to retain whole or large part of earnings to build up reserves to absorb future shocks.In the period of depression the management may also retain a large part of its earnings to preserve the firm's liquidity position. In periods of prosperity the management may not be liberal in dividend payments because of availability of larger profitable investment opportunities. In periods of inflation, the management may retain large portion of earnings to finance replacement of obsolete machines. 2. State of Capital Market: Favorable Market: liberal dividend policy. Unfavorable market: Conservative dividend policy. 3. Legal Restrictions: Companies Act has laid down various restrictions regarding the declaration of dividend:Dividends can only be paid out of: Current or past profits of the company. A company cannot declare dividends unless: It has provided for present as well as all arrears of depreciation. Certain percentage of net profits has been transferred to the reserve of the company. Past-accumulated profits can be used for declaration of dividends only as per the rules framed by the Central Government 4. Contractual Restrictions: Lenders sometimes may put restrictions on the dividend payments to protect their interests (especially when the firm is experiencing liquidity problems) B.Internal Factors af fecting dividend decisions 1. Desire of the Shareholders: Though the directors decide the rate of dividend, it is always at the interest of the shareholders. Shareholders expect two types of returns: [i] Capital Gains: i. e. , an increase in the market value of shares. [ii] Dividends: regular return on their investment. Cautious investors look for dividends because, [i] It reduces uncertainty (capital gains are uncertain). [ii] Indication of financial strength of the company. [iii] Need for income: Some invest in shares so as to get regular income to meet their living expenses. . Financial Needs of the Company: If the company has profitable projects and it is costly to raise funds, it may decide to retain the earnings. 3. Nature of earnings: A company, which has stable earnings, can afford to have a higher divided payout ratio 4. Desire to retain the control of management: Additional public issue of share will dilute the control of management. 5. Liquidity position: Payment of divid end results in cash outflow. A company may have adequate earning but it may not have sufficient funds to pay dividends. Apprising Dividend Policy of PRAN: Year |NI |EPS |Dividend Per |Dividend Payout Ratio | | |(in Millions) | |Share | | |2000 |33. 76 |42. 20% |20. 00% |47. 39% | |2001 |41. 99 |52. 49% |20. 00% |38. 10% | |2002 |43. 41 |54. 26% |25. 00% |46. 07% | |2003 |44. 39 |55. 49% |24. 00% |43. 25% | |2004 |40. 31 |50. 39% |24. 00% |47. 3% | |2005 |40. 77 |50. 96% |26. 00% |51. 02% | |2006 |28. 95 |36. 19% |26. 00% |71. 84% | |2007 |29. 33 |36. 66% |26. 00% |70. 92% | |2008 |35. 95 |44. 94% |28. 00% |62. 31% | |2009 |39. 97 |49. 96% |29. 00% |58. 05% | Table: 1 From the table 1 we see that in 2000 and 2001 PRAN have paid a cash dividend of BDT 20 per share in 2000 and 2001; in 2002 the dividend payment was BDT 25 per share.In 2003 to 2004 and 2005 to 2007 they have paid a cash dividend of BDT 24 and BDT 26 per share respectively. In the year 2008 and 2009 the cash dividend per share was BDT 28 and 29 respectively. Here we see that the dividend has increased in last two year, although the Net Income of the company decreased. However the EPS has also increased during the last two years and the same pattern can be seen in the Market Price of the share. [pic] Figure: 1 From figure 1 we can say that the dividend payment of the PRAN is certain and stable, regardless with earnings.As we see that despite of a drop in the earning in the year 2006 and 2007 the company maintained a constant cash dividend payment which is BDT 26 per Share and when the earnings increased in the year 2008 and 2009 the Dividend payment also increased. [pic] Figure: 2 The Dividend payout ratio indicates the percentage of each unit earned that a firm distributes to the owners in form of cash |Dividend Payout Ratio |= |Dividend Per Share | | | |Earnings Per Share |If we look at the figure 2 we see that to maintain a steady dividend payment per share each year they had to make a huge payme nt out of the Net Income. In 2006 and 2007 the dividend payout ratio was above 70% and in 2008 and 2009 it was above 58%. According to the Regular Dividend Policy the payment of the dividend is a fixed amount in each period. The Regular Dividend Policy also tries to establish to pay out a certain percentage of earnings, however it tries to stabilize the dividend by pay out a certain amount of dividend and it adjusts the dividend towards the target payout as proven earnings increases.In short we can say that PRAN is following the Regular Dividend Policy Constrains of Regular Dividend Policy: If we have a look at the figure 1 we see that the earnings of PRAN fluctuates year to year for this Regular dividend policy may sometimes prove dangerous. Once a company adopts the regular dividend policy, any adverse change in the dividend payment may result in serious damage regarding the financial standing of the company in the mind of the investors. The same problem is been experienced by PRA N despite of a drop in the earnings that they had to maintain the same amount of dividend.Appropriate type of Dividend Policy: A Stock market tends to be very efficient in the allocation of capital to its highest-value users. That market also helps increase savings and investment, which are essential for economic development. An equity market, by allowing diversification across a variety of assets, helps reduce the risk the investors must bear, thus reducing the cost of capital, which in turn spurs investment and economic growth. However, volatility and market efficiency are two important features which will ultimately determine the effectiveness of the stock market in economic development.In contrast to that the stock market of Bangladesh which is informationally inefficient, investors face difficulty in choosing the optimal investment as information on corporate performance is slow or less available. The resulting uncertainty induce investors either to withdraw from the market unt il this uncertainty is resolved or discourage them to invest funds for long term. Moreover, most of the time it is seen that investors are not rewarded for taking on higher risk by investing in the stock market, or excess volatility weakens investor’s confidence as a result they people avoid investing their savings in the stock market.Due to the imperfect market and the uncertainty of return the investors always aim for short term investment as a result they prefer dividend rather maximizing the firm’s wealth. The regular dividend policy, which ensures a fixed amount of dividend to be paid to the investor regardless to the company’s income during the period, helps to reduce the uncertainly for the investors. For this the Regular Dividend Policy is the appropriate for PRAN. Year |Net Asset Value Per |EPS |Dividend Per Share |Bonus Share |Market Price Per | | |Share | | | |Share | |2000 |258. 39 |42. 20% |20. 00% |- |416. 50 | |2001 |284. 60 |52. 49% |20. 00% |- | 370. 00 | |2002 |312. 82 |54. 26% |25. 00% |- |366. 00 | |2003 |343. 9 |55. 49% |24. 00% |- |412. 00 | |2004 |362. 27 |50. 39% |24. 00% |- |523. 50 | |2005 |386. 55 |50. 96% |26. 00% |- |519. 25 | |2006 |396. 11 |36. 19% |26. 00% |- |386. 00 | |2007 |383. 91 |36. 66% |26. 00% |- |382. 63 | |2008 |428. 9 |44. 94% |28. 00% |- |1142. 00 | |2009 |449. 96 |49. 96% |29. 00% |- |1363. 00 | Net Asset Per Share Vs. Market Value Per Share: Table: 2 From the table 2 we can say that PRAN has never issued any Bonus shares from 2000 to 2009. However they have maintained a steady dividend payment that shows a positive slope. The market price is very fluctuating in 2005 the MV was 519. 25 but in 2006 it went down to 386. 00, in 2007 it was 382. 63 but in 2008 the MV was 1142. 00. [pic]Figure: 2 From the figure 2 we see that till 2007 the Share Market Price and the Net Asset Value Per share is very close however from 2008 the difference between the Market Price and Net Asset value per Share increase d despite of a drop in the Net Income. In the year 2008 and 2009 the corporation has paid a cash dividend of BDT 28 and 29 per share respectively and the EPS in 2008 was 44. 94% and in 2009 was 49. 96. From the above mentioned information we can say that there is a high possibility that the reason behind the increase in the market price of the share imperfect market condition in the Capital Market in Bangladesh.The imperfect market situation might be the result of Syndication or by spreading rumor in the market, which caused the Share Price of PRAN to go up. Capital Structure: In finance, capital structure refers to the way a corporation finances its assets through some combination of equity, debt, or hybrid securities. In other words we can say that Capital Structure is the mix of a company's long-term debt, specific short-term debt, common equity and preferred equity. The capital structure is how a firm finances its overall operations and growth by using different sources of funds .Debt comes in the form of bond issues or long-term notes payable, while equity is classified as common stock, preferred stock or retained earnings. Short-term debt such as working capital requirements is also considered to be part of the capital structure. For example, a firm that sells BDT 20 billion in equity and BDT 80 billion in debt is said to be 20% equity-financed and 80% debt-financed. The firm's ratio of debt to total financing, 80% in this example is referred to as the firm's leverage. In reality, capital structure may be highly complex and include dozens of sources.Gearing Ratio is the proportion of the capital employed of the firm which come from outside of the business finance, e. g. by taking a short term loan etc. A company's proportion of short and long-term debt is considered when analyzing capital structure. When people refer to capital structure they are most likely referring to a firm's debt-to-equity ratio, which provides insight into how risky a company is. Us ually a company more heavily financed by debt poses greater risk, as this firm is relatively highly levered.The Modigliani-Miller theorem, proposed by Franco Modigliani and Merton Miller, forms the basis for modern thinking on capital structure, though it is generally viewed as a purely theoretical result since it assumes away many important factors in the capital structure decision. The theorem states that, in a perfect market, how a firm is financed is irrelevant to its value. This result provides the base with which to examine real world reasons why capital structure is relevant, that is, a company's value is affected by the capital structure it employs.Some other reasons include bankruptcy costs, agency costs, taxes, and information asymmetry. This analysis can then be extended to look at whether there is in fact an optimal capital structure: the one which maximizes the value of the firm. Capital structure in the real world if capital structure is irrelevant in a perfect market, then imperfections which exist in the real world must be the cause of its relevance. The theories below try to address some of these imperfections, by relaxing assumptions made in the M model.Capital Structure Theory: Trade-off theory of capital structure Trade-off theory allows the bankruptcy cost to exist. It states that there is an advantage to financing with debt (namely, the tax benefit of debts) and that there is a cost of financing with debt (the bankruptcy costs of debt). The marginal benefit of further increases in debt declines as debt increases, while the marginal cost increases, so that a firm that is optimizing its overall value will focus on this trade-off when choosing how much debt and equity to use for financing.Empirically, this theory may explain differences in D/E ratios between industries, but it doesn't explain differences within the same industry. Pecking order theory Pecking Order theory tries to capture the costs of asymmetric information. It states that co mpanies prioritize their sources of financing (from internal financing to equity) according to the law of least effort, or of least resistance, preferring to raise equity as a financing means â€Å"of last resort†.Hence: internal debt is used first; when that is depleted, then debt is issued; and when it is no longer sensible to issue any more debt, equity is issued. This theory maintains that businesses adhere to a hierarchy of financing sources and prefer internal financing when available, and debt is preferred over equity if external financing is required (equity would mean issuing shares which meant ‘bringing external ownership' into the company. Thus, the form of debt a firm chooses can act as a signal of its need for external finance.The pecking order theory is popularized by Myers (1984)[1] when he argues that equity is a less preferred means to raise capital because when managers (who are assumed to know better about true condition of the firm than investors) is sue new equity, investors believe that managers think that the firm is overvalued and managers are taking advantage of this over-valuation. As a result, investors will place a lower value to the new equity issuance.. Agency Costs: There are three types of agency costs which can help explain the relevance of capital structure.Asset substitution effect: As D/E increases, management has an increased incentive to undertake risky (even negative NPV) projects. This is because if the project is successful, share holders get all the upside, whereas if it is unsuccessful, debt holders get all the downside. If the projects are undertaken, there is a chance of firm value decreasing and a wealth transfer from debt holders to share holders. Underinvestment problem: If debt is risky (e. g. , in a growth company), the gain from the project will accrue to debt holders rather than shareholders.Thus, management has an incentive to reject positive NPV projects, even though they have the potential to i ncrease firm value. Free cash flow: unless free cash flow is given back to investors, management has an incentive to destroy firm value through empire building and perks etc. Increasing leverage imposes financial discipline on management. Other The neutral mutation hypothesis—firms fall into various habits of financing, which do not impact on value. Market timing hypothesis—capital structure is the outcome of the historical cumulative timing of the market by managers.Accelerated investment effect—even in absence of agency costs, levered firms use to invest faster because of the existence of default risk. Primary Factors influencing the Capital Structure: 1. Business Risk: It is the risk associated with the unique circumstances of a particular company, as they might affect the price of that company's securities. If the business risk is higher than the optimal debt amount will be lower. 2. Tax Position: It is the second key factor.The major reason for using debt i s that the interest is tax deductable which helps to lower the effective cost of debt. However, if much of a firm’s income is already sheltered from taxes by accelerated depreciation or tax loss carried forward from previous years, its rate will be low, as a result debt will not be advantageous as it would be to a firm with higher effective tax rate. 3. Financial Flexibility: It indicates a firm’s ability raise capital on reasonable terms under adverse conditions. 4. Managerial Attitude: It is the firm’s attitude to borrowing fund.Some of the firms are more aggressive than others; hence, some firms are more inclined to use debt in an effort to boost profit. This factor does not affect the optimal capital structure or value-maximizing, however it does influence the firm’s target capital structure. Evaluating the Capital Structure of PRAN: The debt-to-equity ratio (D/E) is a financial ratio indicating the relative proportion of shareholders' equity and debt used to finance a company's assets. Closely related to leveraging, the ratio is also known as Risk, Gearing or Leverage. Year |Equity |Debt |Debt to Equity Ratio|NI |EPS | | | | | |(in Millions) | | |2005 |330. 04 |165. 94 |33. 46% |40. 77 |50. 96% | |2006 |337. 69 |152. 59 |31. 12% |28. 95 |36. 19% | |2007 |327. 93 |114. 00 |25. 80% |29. 33 |36. 66% | |2008 |342. 71 |92. 9 |21. 25% |35. 95 |44. 94% | |2009 |359. 97 |138. 99 |27. 86% |39. 97 |49. 96% | Table: 3 From the table: 3 we can say that that in 2005 when the D/E ratio was 50. 96% the company experienced the highest EPS. If we compare the D/E ratio and the EPS of 2008 and 2009 we see that in 2009 the debt ratio has increased by 6. 61% which had a positive effect on the EPS as a result the EPS increased by 5. 02%. It shows that when the D/E ration increases the EPS also increases.If we look at the graphical presentation it will be easier for us to understand which is given below. [pic] Figure: 4 If we take the average of the D/E ratio from 2005 to 2009 we see that on average PRAN is maintaining a D/E ratio of 27. 90%. In short we can say that 27. 90% of the total equity is financed by Debt. It means that the PRAN is moderately aggressive towards the debt financing. As a result they have a lower Financial Risk and higher Business risk. Conclusion: PRAN is one of the reputed companies in the Dhaka Stock Exchange and they fall under the Category â€Å"A†.From year 2000 to 2009 PRAN has always have paid cash dividend however they have never paid stock dividend. PRAN is maintaining a reserve capacity Dividends can be used to budge assets out of the company and consequently from the potential allege of creditors which can be injurious to creditor wealth, and creditors will beyond a shadow of a doubt take pricing or contractual actions to offset these latent uses of dividends. The contemplations of signaling, agency and the effects of market imperfections upon optimal dividends are imperative dimensions about which financial managers must be sentient. Recommendations:Cash and stock dividend, both should be paid without fail. Our stock market is not an efficient market. The available information most of the times do not lead to the desired reality. Many investors believe on the rumors and invest in the share market. Security Exchange Commission should take proper steps to minimize this condition. Disclosure of the overall market price in the annual report is desirable. The company can ideas from its investors to improve the situation and thereby engaging them in the part of the decision making process. Issuing of bonus shares can be a good option to attract the potential investors.

Made in china

I have never really been one for politics and economics.   Being neither a politician nor an economist, I have never really understood the mechanics of all these deals.   I have always felt that these things are better left to the experts.   Be that as it may, however, the effects and ramifications of all these economic negotiations and deals have invaded into my personal life.   I never expected it to happen but during a recent camping trip of mine I found out just what the trade relations between the United States and China really means in the life of everyday people. It started on a nice and sunny day in the middle of spring.   I was looking forward to the annual camping trip that I and my friends went to.   While we believed in roughing it, we also believed in living with a few luxuries that civilization had made us accustomed to.   In the spirit of â€Å"roughing† it, we had set a limit as to how much we could spend on the items that we were to bring on the trip.   The budget per person was around US $200.   We figured that by setting a cap spending limit we would stick to the bare necessities and experience what it was like to really enjoy camping. In hindsight, I realize that the budget of US $200 that we had set was pretty lean, to say the least.   We had to do away with the usual items that we were used to buying such as portable television sets and the like.   Yet, as we entered the camping goods store, we noticed something different.   There were now so many other cheap goods on sale in the store.   Needless to say, since we had a limited budget, we were overjoyed to realize that we could now splurge on a few more â€Å"essential† items for our camping trip. At the check out counter, we had purchased so many other extra goods.   Aside from the basics such as a tent, flashlight, lamp, sleeping bag and disposable dinner ware, we had also purchased a portable television set, radio speakers and electric generator. As anyone would have guessed, these additional luxury items were made in China.   We never expected that we could buy all these things at a fraction of the price that the same American goods were sold.   In fact, the thing that surprised us the most was the proliferation of these goods into almost every camping goods store in the vicinity. The real lesson on the impact of the United States and China trade relationship was not to be experienced until the camping trip itself. The first few minutes of the trip were relatively uneventful.   We unpacked the items and assigned members to handle the setting up of the various items such as the generator and the tents.   As soon as the basics were set up, we decided to give our new gadgets a go, so to speak.   The first item to screw up was the portable television.   After several minutes of trying to find the right signal, the television set decided that it was also a toaster and it began to emit smoke from the rear panel.   It was not long before the sparks started to fly. Much to ours surprise, the radio speakers soon followed suit, dangerously close to the sleeping bags.   Like clockwork, the generator also followed suit and soon all our made in China goods were either smoking or ablaze. We were left with none of the luxuries that we wanted and only the basic goods that we required for our camping trip.   While a few embers had fallen on the sleeping bags and the tents, they were left relatively un-singed.   The relatively expensive goods by comparison that were made in the United States lasted while the cheap goods from China had broken down even before we had begun to use them. It was that moment that I realized what was really going on in the United States and China trade relationship from an economic and political point of view.   The influx of cheap Chinese goods was a result of the open trade relations that allowed these goods to enter.   The expanded distribution was caused by the relatively low prices that these goods had. I also realized that these things were necessary because trade relations pretty much govern the political relations that countries have with each other.   In order for the United States to tap into the market of China, certain concession had to be made such as allowing trade reciprocity.   The cost of such deals, however, can really be experienced by the normal people such as me.   As the law of supply and demand shows, cheaper is not really better and quality comes at a price.   This I

Business Proposal - 1500 Words

Business Proposal Randy Sickmier ECO/561 September 28, 2011 Dave Sella-Villa Business Proposal This business proposal targets a new market for personal computers; senior citizens. No computer company offers a product designed exclusively for the baby boomer (â€Å"Boomer†) generation. There are â€Å"senior friendly† computers available from most of the major manufacturers, but none make a full commitment to â€Å"senior only† features. The market for computers designed to meet the unique needs of senior citizens, the oldest boomers, is a wide open field with little competition. There are 75 million Boomers in the U.S, about 29% of the population, with the first of this generation turning 64 this year (Baby Boomer Headquarters, 2011). This†¦show more content†¦The company can then make opportunity cost decisions on whether to adjust quantities to achieve maximum profit at MR=MC. Growth in output may also be met by efficiencies and an increase in the company’s production possibilities curve. Production of these computers can be adjusted in the short-run, however, the company’s vision is to ship the same day as the order is received. There are no options with this computer and no delays for customization. Production costs are low which will limit total costs. The production strategy is to create an efficient system using proven but lower cost components. Expensive, ultra-modern technology is not required to meet consumer demand in this segment. Software packages will be smaller and less expensive. The end product will consist of a computer that performs many functions extremely well, but has limited capabilities in some business and academic applications. As examples, some assumptions made during design are that retirees do not want to create a Powerpoint briefing, nor do they need 120 different fonts for word processing. Eliminating these bulky programs save costs and increase the speed and reliability of the computer. The company does not intend to take a loss for the purpose of establishing the brand with seniors. The success of this marketing approach will be evident after the first year of production. If the computer is successfulShow MoreRelatedBusiness Proposal1133 Words   |  5 PagesBusiness proposal A business proposal is perhaps one of the most critical documents you need to learn how to write. It is what spells the difference between success and failure, whether you’re a freelancer or you have a company of your own. In today’s cut-throat business world, entrepreneurs find themselves spending hours upon hours submitting business proposals to potential clients, and not get any results. On the other hand, there are those that are like snipers, able to get the contract afterRead MoreFormal Research vs Business Proposal Essay778 Words   |  4 PagesFormal Research vs. Business Proposals Comparing and contrasting any business proposal can be a little confusing when there is little to no knowledge of what either of the proposal really stands for or mean. Every business has the opportunity for change or to seek change. These business environments are potential projects that intermingled with the start of a new product. Depending on the company or organization’s focus, will determine which proposal is best to provideRead MoreBusiness Proposal Sample1527 Words   |  7 Pages1. Executive summary This is a business proposal about our company. We have done the market research, so that we can show the true and fair information. Our company’s name is D-LIFE. The D-life, letter ‘D’ represents the meaning of DIY, dainty and diamond. It means that our products can help you DIY your life and make your life dainty and shining as if diamonds. Our company tends to sell some DIY-boxes, interesting and attractive DIY desks calendars and pasters for card cover. We regard the youngRead MoreDifferences Between Formal Research and Business Proposals1403 Words   |  6 PagesDifferences between â€Å"Formal Research† and â€Å"Business Proposals† There is a great difference between a formal research proposal and a business proposal. In fact these two types of proposals seem to be very similar but there are critical differences in the overall purpose, uses and goals. With such distinct differences for a writer it helps in understanding for writing the formal research proposal or business proposal more effectively. The general purpose of a proposal is the identify a particular need, explainRead More Business Proposal for Library at the Exton Campus of Delaware County Community College1294 Words   |  6 PagesBusiness Proposal for Library TABLE OF CONTENTS Background1 Current Environment.2 Proposed Environment...3 Diagram.4 Benefits.6 Business Requirements and Cost Analysis...8 Conclusion9 BACKGROUND I am proposing for a library to be put into the Exton campus of Delaware CountyRead MoreHome Depot Business Proposal2903 Words   |  12 PagesHome Depot Business Proposal Easter B. Fulton ECO 561 June 22, 2015 J. Carl Bowman Home Depot Service The Home Depot was founded in 1978 in Atlanta, Georgia as the first home retail store by Bernie Marcus and Arthur Blank (Home Depot, 2014). To give an extent of mixes to customers the Home Depot affiliation made key item examination. This helped clients who request to complete structure extends on different business ranges the affiliations innovative stock revolved around internal and outsideRead MoreBusiness Law Proposal : Technology Essay1598 Words   |  7 PagesBusiness Law Proposal The advancement in technology has led to the increase in demand of technological equipment such as computers, servers, photocopiers, printers and power saving machines. The competitive environment that is provided by the information technology has created an increase in demand for the products and has made it possible for Gravity technologies to venture into the market to provide the items that are needed by many companies. The innovations in the market are necessitated byRead MoreKey Proposals For A Small Start Up Business Essay2375 Words   |  10 Pages1 Outline the key proposals contained in the budget for 2015-16 and 2016-17 that may impact on small business owners in Australia. Identify any limitations of these proposals for a small start-up business in regional Australia. The key proposals outlined in the 2015, 2017 and 2017 Federal Budget proposals that may impact small businesses include tax cuts and incentives to â€Å"cut red tape and encourage start ups and entrepreneurship† (Australian Government , 2016). A tax cut of 1.5% will reduce theRead MoreBusiness Proposal for Health, Wellness, Exercise, and Nutrition Outreach Education708 Words   |  3 PagesBusiness Proposal for Health, Wellness, Exercise, and Nutrition Outreach Education Objective: Outreach Foundation, with the support of major sponsors including small business, corporate, and educational institutions, is on a mission to educate students about the importance of diet and exercise in their personal lives. To challenge our youth to visualize their future as fit, strong and healthy citizens that will allow them an expanded vista of enjoyable and healthy athletic activities. With theRead MoreBusiness Case Proposal For Barna Inc3533 Words   |  15 PagesRunning Head: UBER ELITE TRAVELS 1 UBER ELITE TRAVELS 21 A Business Case Proposal for Barna Inc From Uber Elite Travels Amy Brinlee, Jon Daniels, Duane Deeter, Kelley Keppinger, Clayton Wells, Jared Wilson Southeastern Oklahoma State University Logistical Strategies in Aerospace Administration AVIA 5233 Professor David Barna February 23, 2017 Table of Contents Abstract and Introduction 3 Integrated Product Supply Elements 4 Computer Resources 4 Design and Interface 5 Facilities