Question

A sensible payout policy:

A. sets dividends at a level just equal to the amount of new equity that can be raised annually.

B. sets dividends based on net income, not cash flows.

C. consistently varies its target payout ratio on an annual basis.

D. pays out all free cash flows over time.

E. cuts positive NPV investments, if needed, to steadily increase its dividend.

Answer 1

ANSWER

CORRECT ANSWER : option (D) "pays out all free cash flows over time"

EXPLANATION

• A Sensible Payout Policy is basically such Policy which works on both Overall Comany's Growth and at the same time meets Shareholders Expectations with respect to regular Dividends.
• Hence Now let us look at each option one by one :

Option (A) : FALSE because by doing so Company's may pay regular Dividends BUT it will lead to Overall Decline in the Value of Company due to no earnings and such that everytime Dividends are paid out of Fresh Issue of Capital.

Option (B) : FALSE because Net Income might not Reflect the actual cash available with the company to distribute the Dividends at a given point of time so its not a Sensible Payout Policy.

Option (C) : FALSE because this attitude might have an adverse effect on the Shareholder's Expectation as they prefer a Regular Dividends that Fluctuating ones.

Option (E) : FALSE because this strategy might meet the Shareholder's Expectations of Regular Dividends BUT it will Compromise the Growth Aspect of the Company as a whole if they start rejecting "Positive NPV Projects" for the sake of distributing dividends.