Question

a) Referencing textbook readings, lecture material, and current business resources discuss the advantages and disadvantages of having the directors formally announce a firm’s future dividend policy.  Provide an example of a company that recently increased its common stock cash dividend.

b) explain whether or not it would it ever be rational for a company to borrow money in order to pay cash dividends.

Answer 1

Answer a) The advantage is that much like interest, manager may feel an obligation to produce sufficient profit to cover their dividend obligatiomn. Therefore, manager may be inclined to work harder.However , even if the directors formally announce a dividend policy, a missed dividend will not carry the penalty of a missed interest payment (that is potential bankruptancy).

A disadvantage of a formal dividend policy is that it provides manager with less financial flexibility such as ability to fund projects using the internal funds at time when the external financing is too expensive.

Ford has announced a $1 billion special dividend, amounting to $0.25 per share, in addition to its $0.15 per share regular dividend. Ford’s total 2016 planned dividends will be 40% higher than 2015 dividends because of this.

At its current $12 stock price, an investor can earn a 7% return based on the $0.60 common stock dividend planned for this year, as well as the $0.25 per share special dividend payout. That is a very attractive level of income return.

Answer b) Message To Investors : Dividend policies communicate a message to the investors of the company. Companies that pay dividends regularly communicate that the company is stable, growing steadily and rewarding its investors for their commitment to the company. Changes in dividend policies also communicate a message to the investors. When a company with a history of paying dividends chooses not to, the investors perceive this as potential financial difficulties within the organization. When a company with a history of not paying dividends suddenly pays them to its stockholders, the investors perceive this action as an indication of unexpected growth in the company.

Borrowing Money : Sometimes dividend paying companies endure a temporary financial struggle. The company may lack the cash to pay out a dividend one year. The board of directors discusses the message that not paying a dividend will send to the investors. In order to counteract that message, the company may borrow money to pay dividends.