Question

1. The managing directors. of three profitable listed companies discussed their company's dividend policies at a business lunch.

Company A has deliberately paid no dividends for the last five years

Company B always pays a dividend of 50% of earnings after taxation.

Company C maintains a low but constant dividend per share and offers regular scrip issues and shareholder concessions.

Each managing director is convinced that his company's policy is maximizing shareholder wealth.

Required

Discuss the advantages and disadvantages of the alternative dividend policies of the three, and the circumstances under which each managing director might be correct in his belief that his company's dividend policy is maximizing shareholder wealth. State clearly any assumptions that you make

Answer 1

Company A -: Advantage of not paying dividend to the shareholders means that if market situation fluctuates and company is not financialy capable of releasing funds to the shareholders, it will not create a negetive image or attitude among the investors since the company never had a history of paying any sort of dividends in last 5 years.

Although the disadvantage of this modus operandi is that the shareholders/ investors dont feel motivated enouh to be involved with the firm as it does not generate any cashflow for them.

Company B: Pays dividend worth 50% of the earning means that during the times when company does well financialy it will create astream of regular cashflow for the investors in the form of dividends paid to them but if the situation worsens like the current scenario of Covid 19 and its imapct on the economy then it affect the shareholders regular stream of income and hence create a negetive impact on them regarding the organisation.

Company C -: Advantage of constant dividend per share means that although the value might be low. So even though companies PAT falls in any quarter or year, it will still pay the same dividend amount to the shareholders.

On the contrary if the company condition worsens (Financialy or otherwise) then it will be forced to reduce the regular flow of dividends and this gives a negetive image to the investors as well as shareholders.