Final answer:
Liquidating dividends are called so because they are paid from paid-in capital, not from earnings, and are a return of part of the shareholder's original investment. They occur when a company does not have sufficient retained earnings to pay dividends. Investors consider both potential capital gains and dividends when weighing the present value of an investment.
Step-by-step explanation:
The term liquidating dividend is used to describe cash dividends that are debited against paid-in capital accounts because, unlike regular dividends that are paid out of a company's earnings or retained earnings, these dividends represent a return of the shareholders' original investment rather than a distribution of profits. Firms choose to issue liquidating dividends when there are not enough retained earnings to declare a regular dividend, resulting in a reduction of the company's paid-in capital. This scenario might occur in situations where the company has reported a net loss, or when accumulated losses deplete the retained earnings balance.
Issuing cash dividends impacts an investor's rate of return which can be in the form of dividends or capital gains. Differences of opinion about the future prospects of a company influence whether investors want to buy or sell a stock. Investors evaluate what they are willing to pay in the present for a stream of benefits to be received in the future, which includes potential capital gains and dividend payments.