Dividends have been on the headline of business news all the time. Technology co
ID: 2459645 • Letter: D
Question
Dividends have been on the headline of business news all the time. Technology companies | typically pay low or no dividends since they reinvest cash flows in research and development to fund future growth. However, as many technology companies mature (e.g. Microsoft, Dell, Cisco, Oracle, Intel) and build large cash balances, these companies may begin to develop a policy of paying dividends. The tax benefits make such a policy even more attractive. Why is the government considering a tax cut on dividends? What typically happens to a firm's value when it increases its dividend? What would you expect to happen for a high-tech firm such as Microsoft?Explanation / Answer
The government is considering a tax cut on dividends, since dividends typically form a part of the income of the shareholders, and in respect of people who have this as the only source of their income, taxability thereof may lead to additional cash outflows from this income, which may typically be more than the dividends received from the Companies. Further, there will be a double taxation of dividend, being first subjected to tax in the Company which declares the same, and secondly, in the hands of the shareholders, who are the ultimate recipients thereof. When a firm increases its dividend, its value increases since the shareholders have an increased confidence in the operations of the organisation, given its high dividend payout structure. A higher dividend consequently means a higher market value, and a better share price for the Company's shares. For a high-tech firm such as Microsoft, increasing its dividend payout will help increase the market stability of the Company, and subequently, also increase its market capitalisation, and shareholder base, owing to an additional infusion of capital being expected, with the increased confidence of the shareholders due to the payout.