CAPITAL STRUCTURE



Management and Shareholder Wealth



Management and Shareholder Wealth

Question no # 1-a

There is a large impact on the shareholder wealth due to the management decision relating to dividend. There are three different aspects of management's dividend decisions which include changes in dividend, dividend initiations and elimination of dividend. The total wealth of shareholder is the product of number of shares and price of shares. The affect of dividend policy can be clearly seen on the price of share. If the management is not pursuing a constant trend in dividend policy then the shareholders will remain uncertain and the price of share will keep fluctuating which is not a good sign for the wealth of shareholders. If the managements is not declaring dividend from long period of time then the value of shareholder's wealth must be subdued. Moreover, if the management decided not to declare dividend and announce this policy then the shareholder's wealth will be reduced to great extend (Artikis, 2007, pp. 228).

Question no # 1-b

The main factors which are usually considered by management in making dividend policy are level of profit, level of investing opportunities, plan of issuing new shares in near future and tax incentives in case of raising debt. If the management has achieved the desire level of profit then the chances of declaring dividend are high. If the management has sufficient amount of fund but management also have attracting investing opportunities which ensure high return then management will prefer to avail those opportunities then declaring dividend. If the management foresees that there will be a need of funds in near future and planning to raise capital through equity then it will declare and issue dividend to make the stock attractive. If management believes that the benefits of raising capital through issuing bond are higher as compared to benefits of issuing equity then the management will again prefer to declare dividend lower because stock is no more required to be attractive (Artikis, 2007, pp. 228).

Question no # 2-a

There are many capital structure theories that are proposed by different theorists where they claim that it is possible to make optimal capital structure such as Net Income theory of capital structure, Net Operating income theory of capital structure, Traditional Theory of capital structure and Modigliani and Miller theorem, trade-off theory of capital and pecking order theory. There are certain limitations in each of these theories therefore it is not possible to make optimum capital structure in real world. There are certain assumptions of every theory which are mentioned below:



Investors have complete and equal amount of knowledge about the market.

The risk of firms is same for all firms and capital structure has nothing to do with the level of risk.

No corporate taxes.

The transactions costs are zero.

The rate of interest for Individuals and corporations are same.

The dividend-payout ratio is 100.

The average cost of capital remains constant.

The total assets do not change.

The operating profits will remain constant.

It is not possible to fulfil these kinds of assumptions in the real ...