Question

Say you issue $1000 worth of common dividends. What happens to Enterprise and Equity Values? How about preferred dividends? Assume the company uses cash to fund these dividends.

a) Enterprise Value increases, Equity Value decreases, Preferred dividends increase
b) Enterprise Value decreases, Equity Value decreases, Preferred dividends increase
c) Enterprise Value increases, Equity Value decreases, Preferred dividends decrease
d) Enterprise Value decreases, Equity Value decreases, Preferred dividends decrease

Answer 1

Issuing $1000 in common or preferred dividends using cash reduces Equity Value but does not affect Enterprise Value. No option given in the choices accurately represents this outcome. Dividends do not typically lead to an increase in themselves as they are distributions of earnings.

Step-by-step explanation:

When a company issues $1000 worth of common dividends and uses cash to fund these dividends, Equity Value decreases because cash is an asset that is leaving the company and reducing shareholders' equity. On the other hand, Enterprise Value does not change because it reflects the total value of the company (including debt and excluding cash), and paying dividends does not affect the operational value of the company. When it comes to preferred dividends, these also typically come out of the cash reserves and thus have a similar effect on equity value, which decreases. However, like common dividends, they do not affect the enterprise value.

Therefore, the correct answer to what happens when you issue $100 worth of common or preferred dividends is: Enterprise Value remains unchanged, and Equity Value decreases. There are no options in the given choices that accurately depict this scenario. Common and preferred dividends paid out to shareholders are not expected to increase as a result of the dividend payment; instead, they are simply distributions of earnings.