Question

Explain why investors often see a cut in a company’s dividend payment as a negative signal.

(b)

If a company is planning a cut in its dividend how should it go about this?

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What are the potential consequences for companies whose dividend policies are out of step with

their financial performance?

(d)

What impact is a recession likely to have on companies’ dividend yields?

(e)

Is a high dividend yield a good thing or a bad thing for investors?

(f)

Discuss the practical issues to be considered by a company when deciding on the size of

its dividend payment.

(g)

XYZ’s current cum dividend share price is £3.45 and the company has just announced a dividend per share of 20p. At what rate do investors expect dividends to grow in the future if the current share price is considered to be fair and if shareholders require a rate of return of 15 per cent?

(h)

Given the assumptions made by Miller and Modigliani’s dividend irrelevance theory, do you consider their conclusions to be logical?

Answer 1

(a) Explain why investors often see a cut in a company’s dividend payment as a negative signal.

A divident-cut usually leads to a acute decline in the company's stock price. Hence, investors know that the company's financial situation is weakening gradually. This would definitely raise alarm bells inside an investor's mind and would often discourage potential investors from investing in the company.

(b) If a company is planning a cut in its dividend how should it go about this?

The ideal thing to do would be to avoid a total divident cut (drastically stop paying dividends) and make a proportionate reduction in the amount of dividends it pays to its investors. That way, the investors would still believe that things might not go bad in the long run.

(c) A company whose dividend policies are out of step with their financial performance might have the following problems -

1. The company's financial position is weakended as it's net earnings will be eventually depleted
2. A direct consequence of the above statement would steer the company into debts that would be hard to recover from
3. To repay back loans and debts,the company's stock prices would decline
4. Potential investors would be pessimistic about investing in the company
5. The company's brand value would drastically reduce

(d) Impact of a recession on dividend yields :

• Dividend cuts - To account for a company's income losses, investors would suffere dividend cuts.
• Change in stock prices(often reduction) would steer even stringent dividend cuts; even to the point of a complete stoppage of dividend payments
• Hence, dividend yields would see a steady dip