Reference no: EM132255616

Discussion :

In a capital market it is often viewed as favorite for a firm to pay dividends to shareholders versus repurchase shares. Dividends are a portion of the company's actual profits and they can choose to pass on to shareholders or the company can choose to purchase some of the outstanding shares.

It can be advantageous for a company to pay dividends to shareholders to show the company's profits and reduce the net income of the company.

Shareholders are happy and are able to choose what to do with the dividend; reinvest or cash out. On the other hand it can also be advantageous for a company to buy their own shares to reduce the number of shares outstanding and increase cash flows with huge tax advantages. With these positive points on each end it can be a really hard decision for a company to make. Tax preference is determined by who is receiving the benefit.

For example, shareholders receive the dividend therefore they pay the taxes on it. If the company buys any shares they are have a tax deduction/credit. Managers acting in the interest of long-term shareholders are more likely to buy shares when they believe the company is undervalued.

It is advantageous to do this because the shares that are purchased are outstanding trading at a lower price and the outstanding shares reduce the earnings per share, making cash flow improve (Brigham & Ehrardt, 2017). These adjustments may not seem like a lot but it allows the company to set itself up for success. In conclusion, a capital market it is important for a company to strategically pay out dividends or buy outstanding shares.

References:

Brigham, E. F., & Ehrhardt, M. C. (2017). Financial management: Theory & Practice, (15th ed.). Boston