Question

• Identify the optimal capital structure of a U.S. corporation and analyze the requirements for using long-term debt, common stock, and preferred stock financing.
• Identify the key factors involved in establishing a dividend policy.

Your answers must provide clear evidence of critical thinking.  Your answer add greater depth to the discussion by introducing new ideas.

Answer 1

1.Key factors involved i establishing a dividend policy are as follows -

A.Income stability is one of the top factors in determining dividend policies. Specifically, established companies with stable, predictable income streams are more likely to pay dividends than companies with growing or volatile income.

B.the potential for better returns through capital reinvestment.

C.Dividends are effectively taxed twice -- once at the corporate level, and again when they are paid out to shareholders.

Because of this, many companies (and their investors) feel that other methods of returning capital, such as share repurchases, are a better way to go.

D.Fulfilling legal requirements.

E.If a certain sector is having trouble and anticipates profits falling, it's common for companies to get quite defensive when it comes to their dividends.So Economic conditions and market environment matters.

2.As regards the optimal capital structure

A.There is no magic ratio of debt to equity to use as guidance. What defines a healthy blend of debt and equity varies according to the industries involved, line of business, and a firm's stage of development. However, because investors are better off putting their money into companies with strong balance sheets, it makes sense that the optimal balance generally should reflect lower levels of debt and higher levels of equity.

B.Use of leverage (debt) is good. It increases the amount of financial resources available to a company for growth and expansion. With leverage, the assumption is that management can earn more on borrowed funds than what it would pay in interest expense and fees on these funds. However, to carry a large amount of debt successfully, a company must maintain a solid record of complying with its various borrowing commitments.