BUS224 Corporate finance Name: Parimal Dubey Student Id : 31974299

Question 10. Usually the board of Directors increase dividend per share only slowly in response to rising profits and is even more reluctant to decrease dividend per share than to increase it. Give reasons for this behavior pattern. Is this behavior more likely to be observed under an imputation tax system than under a classical tax system? Why/why not? Answers: Dividends are payments made by a corporation to its shareholder members. A dividend is allocated as a fixed amount per share. Therefore, a shareholder receives a dividend in proportion to their shareholding. Dividend per share (1) or DPS is the sum of declared dividends for every ordinary share issued. When a corporation earns a profit or surplus, that money can be put to two uses: it can either be re-invested in the business (called retained earnings), or it can be distributed to shareholders. There are two ways to distribute cash to shareholders: share repurchases or dividends. Many corporations retain a portion of their earnings and pay the remainder as a dividend. However, Board of Directors do realize the importance of dividends in short and long term perspective when it comes to its distribution to shareholders is just not merely based on earnings but other factors as well: 1) Generally people sentiments are directly influenced by stock market movements which are directly linked to dividend yields and fiscal profits announcements by companies which expose them to market risk. Usually, the best way would be keeping the DPS low most of the time, even in times of high earnings and distribute, may be, only once in three quarters. This allows the corporation to reinvest the retained earnings back into the business, have a fiscal surplus and leverage on gradual increment of people sentiments/ market value. On the other hand, if they deliver high dividends every time, they would have a little room for retained earnings. Moreover, it will be more likely to create higher negative market risk as it will drive the DPS->Equity-> stocks downwards compounding the losses of the corporations during tough times. This practice of dividend diversification actually helps to mitigate the negativity during the bad economic times . 2) Low dividend distribution also allows entities to keep more money for reinvesting, issuing new shares and pursue other business opportunities. It helps them to take more loans, leverage on debt in order to proceed with high NPV projects. It is rightly said the aforesaid behavior more likely to be observed under an imputation tax system than under a classical tax system. Franking credits is a type of tax credit found in countries such as Australia that allows domestic companies to pass through taxes that have already been paid on corporate profits. The investor receiving stock dividends will also receive a quantity of franking credits in proportion to the overall tax rate of the company per dollar in profits. The advantages of Franking credits is that it helps to decrease the tax imposed on the dividends received by shareholders of the company. In classical system, entities will need to pay company tax (leading to terms such as Earning before interest and tax, Earnings before income tax) to get the Net income. When dividends are received by the share holders, they will also need to pay personal tax on the overall monetary position including dividends receive. In short, Franking credits offset a portion of the dividends which used to be under taxation previously, creating more security, value and optimism for the shareholders.

BUS224 Corporate finance Name: Parimal Dubey Student Id : 31974299

Referencing: 1. 2. Anonymous. (2012). Dividend. Available: http://www.investopedia.com/terms/d/dividend.asp#axzz2C7A466Sd. Last accessed 14th Nov 2012. Anonymous. (2012). Franking credits. Available: http://www.investopedia.com/terms/f/frankingcredit.asp#axzz2C7A466Sd. Last accessed 14th Nov 2012.

Glossary: 1. DPS can be calculated by using the following formula:

D - Sum of dividends over a period (usually 1 year) SD - Special, one time dividends S - Shares outstanding for the period