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(a) A political advisory committee recently recommended wage and price controls to prevent the spiraling inflation that was experienced in the 1970s

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(a) A political advisory committee recently recommended wage and price controls to prevent the spiraling inflation that was experienced in the 1970s. Members of the investment community and several labor unions have sent the committee reports that discuss whether or not dividends should be under the controls.

The reports from the investment community demonstrated that the value of a share of stock is equal to the discounted value of its expected dividend stream. Thus, they argued that any legislation that caps dividends will also hold down share prices.

The union reports conceded that dividends are important to shareholders, but only because the dividend is the shareholders’ wage. In order to be fair, the unions argued, if the government controls labor’s wage, it should also control dividends.          

b) Comment briefly on each of the following statements:

(i) “Unlike new capital, which needs a stream of new dividends to service it, retained earnings are essentially free capital.”

(ii) “If a company repurchases stock instead of paying a dividend, the number of shares falls and earnings per share rise. Thus stock repurchase must always be preferred to paying dividends.”