Chapter 10 - Dividend policy

Question 1

What are the advantages of internal sources of finance?

Answer 1

• Immediately available

- No issue costs

Question 2

What are the disadvantages of internal sources of finance?

Answer 2

• Use of shareholder funds

- Could be paid out as dividend

Question 3

What are the different dividend policies?

Answer 3

• Constant payout
• Stable growth
• Residual policy

Question 4

What is a residual policy?

Answer 4

Dividends are only paid out once all positive NPV projects are invested in

Question 5

What are the assumptions of the M&M dividend irrelevancy theory?

Answer 5

• No taxes
• Efficient capital markets - realistically capital rationing could be issue
• No transaction costs
• Perfect information

Question 6

What does the dividend irrelevancy theory state?

Answer 6

The in a tax-free world, shareholders are indifferent between dividends and capital gains. Dividends can be manufactured by selling shares.

Question 7

What is a scrip dividend?

Answer 7

Dividend paid in shares

Question 8

What is the result on share price of a share repurchase?

Answer 8

It increases as less shares available

Question 9

Why are convertible bonds more attractive to a company than a loan from a bank?

Answer 9

• Lower interest rate because of conversion rights
• Possibility of not redeeming debt at maturity
• Influx of cash
• Gearing reduced on conversion as equity replaces debt - positive signals