Common stock, dividend rates

Common stock, dividend rates on, 248-249 Company policies, effect on cost by, 155 Comparison, of different processes items to consider in, 34-36 investment, 9-11, 315-329 Compartmentalization for capital investmenf 191-193... 

Interest on loans from banks, preferred stock and bonds is paid at a fixed rate of interest. A share of the profit of the company is paid as a dividend on common stock and preferred stock (in addition to the interest paid on preferred stock). 

The cost of capital is what it costs a company to borrow money from all sources, such as loans, bonds, and preferred and common stock. It is an important consideration in determining a company s minimum acceptable rate of return on an investment. A company must make more than the cost of capital to pay its debts and make a profit. From profits, a company pays dividends to the stockholders. If a company ignores the cost of capital to increase dividends to the stockholders, then management is not meeting its obligations to pay off outstanding debts. 

New capital may also be obtained from the issue of bonds, preferred stock, or common stock. Interest on bonds and preferred-stock dividends must be paid at fixed rates. A relatively low interest rate is paid on bonds because the bond-holder has first claim on earnings, while higher rates are paid on preferred stock because the holder has a greater chance to lose the entire investment. The holder of common stock accepts all the risks involved in owning a business. The return on common stock, therefore, is not at a fixed rate but varies depending on the success of the company which issued the stock. To compensate for this greater risk, the return on common stock may be much higher than that on bonds or preferred stock. 

The cost of new capital obtained from bonds, loans, or preferred stock can be determined directly from the stated interest or dividend rate, adjusted for income taxes. However, the cost of new capital obtained from the issue of common stock is not so obvious, and some basis must be set for determining this cost. Probably the fairest basis is to consider the viewpoint of existing holders of common stock. If new common stock is issued, its percent return should be at least as much as that obtained from the old common stock otherwise, the existing stockholders would receive a lower return after the issue of the new stock. Therefore, from the viewpoint of the existing stockholders, the cost of new common stock is the present rate of common-stock earnings. 

Investors hold stock in companies because they are interested in a return on their investment. The return could come from dividends paid to the stockholder or from appreciation in the market value of the stock. Dividend yield is the ratio of the dividend paid per common share to the market price per common share. This gives investors some idea of the rate of return they will receive in cash dividends from their investment. Low dividend yield companies generally keep a large portion of net income funding growth and expansion. Many well-known high tech companies do not pay dividends for this very reason to fund growth and e q)ansion. 

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