Implications of dividend payout level for Gainesboro’s capital structure
Black (1996, pg. 9) examined a theory developed by Miller and Modigliani and found out that “the higher the dividend, the less the investor receives in capital appreciation.” He further explained that when a firm pays out dividends to shareholders there is the effect of reduced cash equivalents that the firm holds or causes an increase on the amount of cash generated from issuing the dividends (Black, 1996). From these observations a mathematical expression can be generated to indicate the relationship between the percentage of dividend payout and the capital structure of a firm. Therefore, a 20 % payout level for Gainesboro Corporation has the following implication on the capital structure:
Dividend payout = 1 / Capital structure
0.20 = 1/ capital structure
Capital structure = 5
From the above calculations, it is evident that a dividend payout of 20 % causes an increase in capital structure by 5. On the other hand, a 40% payout level for Gainesboro Corporation has the following implication on the capital structure:
Dividend structure = 1 / Capital structure
.40 = 1 / Capital structure
Capital structure = 2.5
It is evident that from the above calculations a 40 percent dividend payout causes a 2.5 change on the capital structure. It is concluded that as the dividend payout increases the amount of capital structure declines. A 20% dividend payout causes a change on the capital structure by 5 while a 40 percent dividend payout policy causes a 2.5 change on the capital structure. A 20% payout level will improve the capital structure of Gainesboro since the corporation will have more retained earnings to make more investments. Adopting 40% payout level for Gainesboro Corporation will reduce the capital structure. By using the 40 % payout policy system, the company will reduce the amount of capital available for operating the business.
Implications of dividend payout level for Gainesboro’s unused debt capacity
Black (1996, 10) is of the opinion that “when a company has debt outstanding, the indenture will almost always limit the dividends the company can pay.” He also explained that when dividends are paid out to shareholders a company reduces its capacity to borrow from creditors (Black, 1996). It is from this theory that a conclusion can be made that there is an inverse relationship between the dividend payout level and the unused debt capacity. The lower the dividend payout levels the higher the unused debt capacity.
When a 20% dividend payout level is adopted the unused debt capacity will be:
Dividend payout level = 1 / Unused debt capacity
0.20 = 1 / Unused debt capacity
Unused debt capacity = 5
On the other hand, when a dividend payout level of 40% is adopted the unused debt capacity will be:
Dividend payout level = 1 / unused debt capacity
0.40 = 1 / Unused debt capacity
Unused debt capacity = 2.5
It can be concluded that an increase in the amount of dividend payout causes a decrease on the unused debt capacity. A higher dividend payout level causes a decline on the capacity of the firm to obtain external debts.
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