8. Your firm has had steady earnings for many years but it has resisted paying d

Question

8. Your firm has had steady earnings for many years but it has resisted paying dividends. It typically uses its earnings to finance replacement of its worn out assets, thus saving the cost of borrowing money to do this. Its stock price has not risen much in recent years. The Drucker-educated consultant tells the CEO to start paying a modest dividend out of earning. "The borrowing costs you will incur by occasionally having to raise money with debt will be outweighed by a subtle benefit." What subtle benefit is the consultant referring to?

Explanation / Answer

Subtle benfit is the rise in stock price due to dividend payments. When dividend payments rise, the price increases thus decreasing the required return or the cost of capital.

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