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DIvidend Policies and Financing

Extracts from this document...

Introduction

1.0 Introduction Dividend policy refers to the decision made by the company whether to retain the profits within the company, or they pay out the profits to the owners of the organization in the form of dividends (Garrison 2008). Once the company decides on whether to pay dividends, they may establish a somewhat permanent dividend policy, which may in turn impact on investors and perceptions of the company in the financial markets (Garrison 2008). What they decide depends on the situation of the company now and in the future. It also depends on the preferences of investors and potential investors (Garrison 2008). When deciding on the dividend policy, several factors such as legal constraints, contractual constraints, internal constraints, growth prospect, owner's considerations and market considerations have to be taken into account. Considerations taken into account can be incorporated in several dividend theories such as the residual theory of dividends, the clientele theory, the signalling dividend theory, the bird-in-the-hand theory and Modigliani and miller dividend theory. Manufacturing overseas can reduce costs due to its cheap labour costs but there are other considerations that have to be taken into account. There are pros and cons for manufacturing at overseas. Company's capital structure refers to the way a corporation finances its assets through some combination of equity, debt, or hybrid securities (http://en.wikipedia.org/wiki/Capital_structure). Debt financing and equity financing has their own advantages and disadvantages but certain factors have to be considered when choosing between these two financing strategies. 2.0 Factors Affecting the Dividend Policy When deciding on the dividend policy, several factors need to be taken into account. The factors needed to taken into account are as follows (sources taken from http://freemba.in/articlesread.php?artcode=488&substcode=30&stcode=10): Stability of Earnings The nature of business has an important bearing on the dividend policy. Industrial units having stability of earnings may formulate a more consistent dividend policy than those having an uneven flow of incomes because they can predict easily their savings and earnings. ...read more.

Middle

doesn't affect the overall value of the firm. Stockholders are indifferent as to whether they receive their return on their investment in the firm's stock from capital gains or dividends so dividends don't matter. 2.2 Advantages and Disadvantages of Overseas Manufacturing Manufacturing at overseas certainly saves cost of production in some degree due to cheap labor and material cost but it has its advantages and disadvantages for overseas manufacturing. 2.2.1 Advantages of Overseas Manufacturing Ease and Speed of Distribution: Manufacturing in overseas shortening the distance between the original location of manufacturer and its distribution market (if the manufacturer has its markets around the region of the considered location). For example, when Nike manufacturer from United States manufactures in Malaysia, they have greater ease and speed of transportation for goods and people to other Asian markets. Besides that, transportation and shipping cost may be reduced due to a shorter distance for shipping and distribution. Cost Savings: In less-developed countries, labor cost is cheaper than developing and developed countries. It is estimated that a company that manufactures in less-developed country can cut costs by between 30% and 80% depending on how labor intensive the product is. Besides that, material cost is also cheaper compared to developed countries too. Gain in Efficiencies and Economies of Scale: Besides that, in the long run, manufacturing overseas can gain efficiencies and economies of scale which will assist in reducing unit cost as output increases. Moreover, the initial investment of capital may be spread over an increasing number of units of output and therefore the marginal cost of producing a good or services decreases as production increases. Low Capital Costs: Low capital cost is one of the advantages that encourages manufacturing overseas. The cost of capital in developing or developed countries is higher than the cost of capital in less-developed countries. Incentives for Manufacturing: Some of the less developed countries encourage overseas manufacturers to invest or manufacture in their country. ...read more.

Conclusion

The Cost of Financing: The cost of financing for debt financing is cheaper than equity financing due to the debt financer is exposed to lesser risk and he is entitled for prior claim in the company's profits and interest payable are tax deductible (which means actual cost of debt is lesser) (Joseph 2008). The Duration of Borrowing: The longer the duration, the interest rate charged on the borrower will be higher (Joseph 2008). The Current Gearing Level: If a company has a high gearing level, it is the best to go for equity financing whilst if a company has a low gearing level, they can go for debt financing (Joseph 2008). 4.0 Conclusion Not every dividend policy suits a company. When deciding on how much dividend should be distributed to their investors, factors such as legal constraints, contractual constraints and etcetera have to considered to obtain the most suitable and appropriate dividend policy for better financing. Factors that affect dividend policy can be incorporated in several dividend theories such as residual dividends theory, clientele theory, signalling dividend theory, bird-in-the-hand theory and Modigliani & Miller dividend theory. These theories can be classified into dividend relevance theory where its dividend policy will affect on company's value and cost of capital and dividend irrelevance theory where its dividend will not affect on company's value and cost of capital. Overseas manufacturing gains advantages such as cost savings and economies of scale. Inversely, it also has other effects such as no expertise available and also time consuming for starting a new factory. Company's capital structure can be financed through debt financing and equity financing. These are the strategies that a company can get its fund. However, these two strategies have their own advantages and disadvantages. When implementing any of those strategies, factors such as size of the company, ability to generate cash flow, current gearing level and other factors have to be considered in order to have the most suitable strategy to finance the organization. 5. ...read more.

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