Question 4 OR (b)

Six factors that influence a firm's dividend policy

6 marks

Time to write
About 12 minutes
Topic
Dividend theories and dividend policy

Question

Question 4 OR (b) · 6 marks

Elucidate any six factors that influence the dividend policy of a firm.

Reworded from the university paper; the task is the same. The original paper belongs to the University of Delhi. See DU's question bank.

Before you write

Read off the question and its marks

12 minfor 6 marks

Read from the question

  • any sixThe paper asks for any 6, and this is one of them. Only 6 are marked: a further earns nothing.

Write it in this order

  1. Read; underline the asks; jot your points 1 min
  2. 1 Six factors explained, one mark each 6 marks 10 min
  3. Check: every ask answered, key terms underlined 1 min

Try it first. About 12 minutes for 6 marks. Write it out, then open the solution.

Solution

Hover or tap a marked figure, like 72,000, to see how it is made and where else it appears.

  1. Profitable investment opportunities. When the firm has investments earning more than shareholders require, it pays to retain earnings; growth companies therefore have low payout ratios, while mature companies with few opportunities pay out more.
  2. Liquidity (cash position). A dividend is a cash outflow, so the ability to pay depends on the firm's cash and liquidity, not merely on its profits; a growing firm with good profits may still need its cash for expansion.
  3. Cost and availability of funds. Retained earnings save flotation costs and avoid dilution of control. If finance can come from cheaper debt, more can be paid out; if it would have to come from new equity, retention is preferred.
  4. Access to the capital market and control. If new shares would have to be issued to replace the cash paid out, and existing shareholders cannot buy them, their control is diluted; dividends may then be withheld.
  5. Expectations of shareholders. Investors who want regular income prefer current dividends, while those investing for growth accept retention; the firm weighs the effect on its share price, since higher dividends generally raise the market value of shares.
  6. Legal constraints. The Companies Act, 2013 (section 123) restricts when and out of what profits a dividend may be declared.
Picture itSix factors that influence a firm's dividend policy

1With the new plant half-built outside the window, the board votes to keep the coins in the bag.

Investment opportunitiesA company with profitable investments in hand prefers to retain more of its earnings to finance them.

2The retired couple at the AGM would rather have the envelope today.

Expectations of shareholdersShareholders who invest for regular income prefer current dividends to future growth.

Where the 6 marks sit

#ComponentMarks
1Six factors explained, one mark each6
Total6
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