Dilemma: Should the firm use retained earnings for a) Financing profitable capital investments? b)paying dividends to stockholders?
Dilemma: Should the firm use retained earnings for: a) Financing profitable capital investments? b) Paying dividends to stockholders?
P1 DI Return Po If we retain earnings for profitable investments
• If we retain earnings for profitable investments, P1 - Po D1 Po Po Return = +
P1 DI Return Po If we retain earnings for profitable investments, dividend yield will be zero
• If we retain earnings for profitable investments, dividend yield will be zero, P1 - Po D1 Po Po Return = +
P1 DI Return Po If we retain earnings for profitable investments, dividend yield will be zero, but the stock price will increase, resulting in a higher capital gain
• If we retain earnings for profitable investments, dividend yield will be zero, but the stock price will increase, resulting in a higher capital gain. P1 - Po D1 Po Po Return = +
P1 DI Return Po If we pay dividends
• If we pay dividends, P1 - Po D1 Po Po Return = +