Cost and Benefits

The cost and benefits of retaining excess funds into the company can be analyzed by determining tax and agency cost effects.

Tax Effects:

If a company decides to pay out the excess cash as the dividend, then this amount will be taxed twice once at the corporate level and once when it is distributed to the shareholders. Hence the double taxation will make the equity as the costly source of finance.

However, if themarginal corporate tax rate is lower than the personal tax rate, then there will be no adverse consequences with the perspective of the tax to retain excess funds into the company because the ultimate tax on the excess funds will be lower in this case as opposed to another case.

The personal tax rate is 38% while the corporate tax rate is 35%, therefore, it will be beneficial to retain excess funds into the company because in this case, the excess funds will tax at a lower amount.

As the House of Representativeshas changed tax over dividend and made it 15%, therefore now it will not be beneficial for the company to retain excess cash because if now company retains itthen it will be taxed at a higher rate hence it will increase the overall cost of the retention.

Agency Cost Effects:

Corporate agency problems are defined as the conflict between the managers and the stockholders of the company. In Linear Technologies, the company granted options to its employees.The CEO of the company Robert Swanson has approximately 1.53million of common shares and options worth approximately $345million. Hence, therefore, we can say that any excess funds which are retained in the company can be used in enhancing the overall value of the shares and ultimately the value of the company.

Options 1.00 29.1
Common Stock        0.53 316
Total        1.53 345.1

 

However,the Chief Financial Officer of the company, Paul Coghlan stated that the firm has no intention to pursue any acquisition in the near future, therefore,the retention of excess funds into the company may be costly for the company because after retaining them company will lose the opportunity cost.In this case, opportunity cost is related to the increase in the value of the shares. Company pays cash to its shareholders either in the form of dividend or shares buyback.

Moreover, there is also a risk that if company retains excess funds, then management of the company may use these funds for their personal use hence it will be the misuse of company resources and therefore will be unprofitable for the company.

The choice between Dividend and Share Repurchase:

If Linear Technologies has surplus funds, then it may use these funds in many ways. However,if thecompany intends to pay this either as a dividend or to repurchase shares, then the decision should be made after considering the following elements………………………

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