Cost of Equity and Dividend Policy

The economically justified amount of dividends is equal to the equity cost, assuming that investors use a dividend discounting model. The evaluation of the latter is an extremely difficult task. It is possible to do this within modern capital structure theory — Brusov-Filatova-Orekhova (BFO) — or within its perpetual limit — the Modigliani-Miller (MM) theory. After the recent generalization of both theories, taking into account the real conditions of the functioning of the companies, it becomes possible to estimate the cost of equity in these conditions. Dependence of the cost of equity on the level of leverage for different ages of the company, different values of k0 (cost of equity at zero leverage level L) and debt costs, different frequencies of income tax payment, advance payments of income tax and payments at the end of periods, variable income of companies, etc. are being studied. Several very important innovative effects have been discovered, which significantly change the company’s dividend policy. The developed methodology and results will help the company’s management to develop an adequate and effective dividend policy. As well, the approach to dividend theory described here can be applied to business valuation and company value.