You should make original posts discussing any three of the following statements.

Question

You should make original posts discussing any three of the following statements. You are also required to post at least three responses to other student’s posts. Please note that this is a minimum requirement. Your grade will be a function of your effort.

1. Explain how the use of leverage can increase shareholder’s wealth.

2. Leverage can also impact you in your personal life. Explain how you can use it to your advantage.

3. In theory, what happens to the shareholder’s worth before and after he/she receives a dividend from the company.

4. What are the advantages of stock repurchases versus paying dividends?

5. What is the impact of a stock split on the value of a corporation? Why do companies do stock splits?

6. What is the difference between a stock dividend and a stock split?

7. If a company is highly leveraged from an operating standpoint is it more likely or less likely to use financial leverage? Why or why not?

Explanation / Answer

1. Increase in leverage means increase in the amount of debt the company takes. As the level of debt increases, the risk of the business also increases because of increased bankruptcy costs and financial distress costs. Since the risk of the business increases, shareholders will want increased return for the increased risk that they take. Therefore the return for the shareholders also increases. Alternatively, as the risk increase, the equity beta of the business increases which is a measure of risk. As per CAPM, increased beta will means a higher expected return for shareholders.

4. Stock repurchases mean the business reduces the public shareholders and wants to increase the shareholding pattern of its promoters. This instils more faith in the shareholders because promoters increasing wealth by buy-back means that the business is sending a signal that it has a strong future outlook.

On the other hand, paying of dividends can be seen as the business not having enough opportunities for future business growth and hence thinks it is best to return the excess profits to the shareholders.

6. A stock split simply means the stock is split. The net market value of the business remains the same. For example if a stock X had 1,000,000 share at $50, now a 2-to-1 split means there would now be 2,000,000 shares at the value of $25.

On the other hand a stock dividend means a portion of the net profits of the business are paid out as dividends for the shareholders based on the decision taken at the annual general meeting of the company. When the dividends are paid the total market value reduces because the stock price reduces to extent of dividend paid and the number of shares remains the same.

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