Dividend policy: BP decided to increase dividend as profit rise

The final stage of maximizing shareholders wealth is how to return benefits to those investors and dividend is one of the ways to return the profits. However, the decision whether company pays dividend or not affect shareholders’ wealth. Miller & Modigliani (M&M) argued that dividend policy and share prices are irrelevant in theory. However, in reality, their argument still work? In reality, divided policy is related to share price.

What make reality different from theory?

Firstly, there is a group of investors concern much about stable and trustful cash flow from dividend. A rapid change of dividend policy, especially cut the amount of dividend (although using as retain earning to invest good future project) cause negative reaction from investors. Why  do investors concern so much about dividend payments? Reality is not perfect. Changing in dividend policy make investors have to change their investment portfolio, suffer tax payment. Both elements create expense which will turn profits of their future investments to dust. Investors will suffer lose due to minimize shareholders’ wealth. Second, the level of future risk acceptations of investors is different. Do you prefer receive dividend today or keep it for future investments which are consider as increase benefits? How many percentages do future projects success? So you would like to receive dividend or reinvest? Moreover, as mention about, reality is not perfect. Investors have to face a lot of expense such as: transactions costs, tax and agency costs.       

Thus, what company should do is keep a stable dividend policy and avoiding suddenly change if does not carefully consider its long-term effects. However, the stable dividend policy often makes investors think about its growth. Does company not develop much which related to unchanged dividend policy? Moreover, if company makes a lot profits while does not have any or have few positive projects, the result is company will keep to much cash due to waste money. All of those affect negative to share price due to shareholders’ wealth.       
        
As a example of dividend policies, according to BBC News (2012), BP has increased its dividend to shareholders by 14% because of increasing in profit. It seems to be a good news to investors. However, in reality, share prices of BP still suffer some lose because the legal liabilities because of the 2010 Gulf of Mexico oil spill continue to affect the company's shares. Thus, does the dividend policy relate to share prices? Or I wonder that because of the legal liability badly affect share price so BP has rise dividend payments in order to attract investors to increase share price which got negative suffer from the liabilities.     

In my opinion, the dividend policy does not solely affect market share price. There are other factors along to dividend policy affects share price.    

Source:   

http://www.bbc.co.uk/news/business-16915491

Capital structure: De Beers plans to cut debt

BBC (2009) stated that De Beers plans to raise its capital investments from investors to $1billion to reduce its debts. I think about my previous lecture topic’s capital structure. If the low level WACC of project presents high level of present value of future cash flows thus shareholders’ wealth is increasing, it will be beneficial to company with high level of debt. As the debt level increases, the actual cost of loan to the company is lower because the interest on the debt is deduced. Moreover, lenders does not share profits to company’s profit. They only require a fixed amount of interest annually. In addition, lenders do not dilute ownership interests and control of existing shareholders. In general, the cost of debt financing is cheaper than equity financing.

However, why De Beers plans to increase equity instead of debt? The problem incurs because of advantage of debt compared to equity which is company only has to pay a fixed amount of money and doesn’t have to pay any extra amount of money when company makes profit. Problem is what about when company makes lose? Company still has to pay that amount of money without any discount. De Beers experiences a bad year in which first-half profits fall by 99% as a result of a collapse in the price of diamonds. How can De Beer pay for the interest of current amount of debt ($3.5bn) while it has financial trouble? In this case, I think the De Beers’ s decision to increase level of equity is right. According to the case, it remind me about the advantages of equity compared to debt, during difficult financial periods, high level of equity can avoid company from risk because equity financing does not require to be paid. Moreover, the larger level of gearing, the more risky lenders and shareholders consider company. Lenders and shareholders would require more interest and dividends to guarantee their interests.

The lesson is that high gearing level is not always is the goods options. There is no perfect capital structure fomula applying to all project and company in imperfect world. In term of diversification approach, company should raising capital by both equity financing and debt financing because the two forms of financing together can work well to reduce the downsides of each. However, working to find out the right ratio is every difficult in order to maximize shareholder wealth. Depend on particular situation; company might decided the suitable capital structure to fit with the requirements. It will vary according to various aspects such as: type of business, revenue and profits, cash flows and a mount of money need to be financed.

Source:

http://news.bbc.co.uk/1/hi/business/8387839.stm