How would each of the following changes tend to affect aggregate payou

QUESTION

How would each of the following changes tend to affect aggregate payout ratios (that is, the average for all corporations), other things held constant? Explain your answers.a. An increase in personal income tax rate.b. A liberalization of depreciation for federal income tax purposesthat is ,
Aggregate payout ratio is equivalent to Divident payout ratio = Dividends/Net Income. For the following items we need to examine the following: a. an increase in personal income tax rate effectively decreases the amount of the dividend (as they are taxed at a higher level), which reduces the numerator of our equation, hence it would reduce aggregate payout ratios. From the stockholders perspective an increase in the personal income tax would make it more desirable for a firm to retain and reinvest earnings. Consequently, an increase in personal tax rates should lower the aggregate payout ratio. b. If the depreciation charges were raised, the rise would tend to reduce reported profits as compared to cash flows, because most firms set up a reserve for deferred taxes, that is, “normalize” reported profits. With higher cash flows, payout ratios would tend to increase. On the other hand, the change in tax-allowed depreciation charges would increase rates of return on investment, other things being equal, and this might stimulate investment, reduce redundant cash flows, and consequently reduce payout ratios. On balance, it is likely that aggregate payout ratios would rise, c. If interest rates were to increase, the increase would make retained earnings a relatively attractive way of financing new investment. Consequently, the payout ratio might be expected to decline as we are again reducing the value for our numerator in the equation. d. and E. are the same. If investment

nities for firms declined while cash inflows remained relatively constant, the payout ratio would most likely increase, because it would maximize the firms value to increase dividend payouts that is, there is no other better use for the earnings other than to release dividends. F. the ability to deduct dividents for tax purposes would act to increase net income, which would increase the numerator on our equation (ceteris paribus), and would increase aggregate payout ratios. G. A change in the tax code makes the dividend policy a moot point from the persepective of the company, they would be taxed regardless of whether gains are realized or not, and these would be at the same rate as dividends. Because the upside potential for a capital gain is greater than the upside potential for dividends (as the company sets dividend policy), a risk averse company would probably issue more money as dividends as opposed to investing in other companies. From the share holders perspective, the “bird-in-the-hand” theory assumes that investors value a dollar of dividends more highly than a dollar of expected capital gains because the dividend yield component, D1/P0, is less risky than the g component in the total expected return equation k= D1/P0 g. Thus (if the board is responsive to shareholder wishes) it would most likely increase aggregate payouts as shareholders would want more dividends as opposed to the potential for capital gains

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