Question

8. Factors that influence dividend policy

Dividend distribution decisions are complicated and involve the understanding of critical strategic factors that affect the policy and value of a firm. Thus, the management of any firm has to consider the constraints on dividend payments, the availability and cost of alternative sources of capital, and other external factors when they create and implement their distribution policy.

Based on your understanding of the constraints on dividend payments, identify the type of constraint this condition represents. Assume that all other factors are held constant.

The (preferred stock restriction OR impairment of capital rule OR bond indenture) states that common dividends cannot be paid if the company has not paid its preferred stock dividends.

Along with several constraints, several internal factors within a company and external macroeconomic factors affect a firm’s dividend policy.

In the table, identify which factors, in general, tend to favor high or low payout ratios.

FACTOR	FAVORS A HIGH PAYOUT	FAVORS A LOW PAYOUT
A closely held firm has a majority of its shareholders in high, marginal tax brackets
A firm had stable earnings in the past and expects stability in the future.
A company recorded high retained earnings but has very little cash and other liquid assets.

When a firm has a large number of profitable investment opportunities, it will usually have a (high OR low) target payout ratio.

A firm with (low OR high) flotation costs is more likely to have a high dividend payout ratio.

Answer 1

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