Your father asked you why his investment in a publicly-traded stock is not payin

Question

Your father asked you why his investment in a publicly-traded stock is not paying him any dividends.

He comments to you that, "as far as I know, the company has never paid me a dividend. I invested in the company to get something back and so far, I have not received anything. Shouldn't the company be looking after its shareholders?"

1. How could you respond to your father to help him better understand the nature of dividend pay-outs and variances among different companies?

2. Should all companies be required to pay dividends? Why, or why not?

Explanation / Answer

AN INVESTOR INVESTS IN A COMPANY AND EARN BY TWO WAYS

1]DIVIDEND

2]CAPITAL GAINS i.e INCREASE IN PRICE OF SHARES

SO IF A COMPANY IS NOT PAYING YOU DIVIDENDS THEN HE RETAINING THE EARNINGS AND PLOUGHING IT BACK.THIS WILL RESULT IN GROWTH OF THE COMPANY AND WOULD INCREASE THE PROFITS WHICH IN TURN WOULD INCREASE ITS SHARE PRICE.HENCE A SHAREHOLDER MAY GAIN AS SHARE PRICES GOES UP DUE TO GROWTH i.e BETTER FUNCTIONING OF THE COMPANY.

2] NO IT IS NOT NECESARY THAT EVERY COMPANY MUST PAY DIVIDEND BECAUSE A GOOD COMPANY WHOSE RETURN ON EQUITY IS GREATER THAN THE REQUIRED RATE OF RETURN WILL INVEST THE DIVIDEND PAYABLE TO THE SHAREHOLDERS AT A RATE HIGHER THAN THAT OF THEIR REQUIRED RATE OF RETURN AS ROE>Re

whereas IF ROE < Re COMPANY SHOULD PAY DIVIDEND TO THE EXTENT IT COULD PROVIDE Re

2ND PART SUPPOSE THERE IS A COMPANY WHO HAS EQUITY AND DEBT IN ITS CAPITAL STRUCTURE. AND IT IS NOT ALLOWED TO RAISE ANY FURTHER FUNDS FROM EQUITY & DEBT.THE ONLY SOURCE WITH IT IS TO RETAIN THE EARNINGS BY NOT PAYING DIVIDEND OR RETAINING ONLY THAT PART OF THE EARNINGS THT IS REQUIRED BY IT AND DISTRIBUTE THE BALANCE AS DIVIDEND.

NOW SUPPOSE EARNINGS OF THE COMPANY IS 5 MILLION THIS YEAR. Re OF SHAREHOLDERS = 12%. ROE = 15%. AND THE COMPANY IS IN NEED OF 5 MILLION NEXT YEAR FOR INVESTING IN PROJECTS THAT WILL PROVIDE 15% RETURN.SO YOU BEING THE SHAREHOLDER WOULD WANT YOUR DIVIDEND TO BE REINVESTED AT 15% INSTEAD OF WANTING THE PAYMENT OF DIVIDEND BECAUSE YOUR EARNINGS ARE INVESTED AT 15% WHICH IS > Re = 12%

likewise vice versa hope now i am clear please rate thanks and keep posting

Related Questions

Navigate

• Browse (All)
• Browse Y
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.