Please Help, question about dividends.

Question

1. How do dividends affect a business as a whole? All I know is that dividends decrease retained earnings because it is net income that was not invested in the business.

Answer 1

While dividends do represent a cost, their value is demonstrated in the demand they create for shares of stock in the company. This makes sense because a stock that produces dividends creates income for the stockholder. This demand drives up the price of the shares, increasing the company's valuation. The next logical question would be: how does this valuation aid the company? First, if demand drives the price of the stocks up high enough, the company could issue additional stock through a number of procedures. The company could then use the revenue from the additional stocks to further grow their business. Second, the company can use their increased valuation as leverage in their own dealings and negotiations. For instance, the company's bank may issue the company a line of credit equal to a percentage of the company's valuation. If the valuation goes up, so too does the line of credit. There are certainly further ways in which dividends affect a company, but this should get you started thinking about the topic. I hope it helps!