Dividend Policy

Question 1

What are dividends?

Answer 1

Payments made by businesses to shareholders, distributing recent profits to owners.

Question 2

What are the two types of dividends?

Answer 2

• Cash dividends * Stock buy-backs

Question 3

What legal limits affect dividend payments?

Answer 3

Dividends can only be paid from accumulated realised profits less any accumulated realised losses.

Question 4

What is the maximum legal dividend a company can pay?

Answer 4

The amount of the revenue reserves.

Question 5

What is the Dividend Cover Ratio (DCR)?

Answer 5

DCR = Earnings for the year available for the dividends / Dividend announced for the year.

Question 6

What does ‘cum dividend’ mean?

Answer 6

Share prices include accrued dividends payable.

Question 7

What does ‘ex dividend’ mean?

Answer 7

Share prices exclude the accrued dividend.

Question 8

What is the Ex-Dividend Date?

Answer 8

A period starting one business day prior to the record date, when a stock is sold without the right to receive the current dividend.

Question 9

What is the formula for Dividend Per Share (DPS)?

Answer 9

DPS = Total Dividend / Outstanding Ordinary Shares.

Question 10

How is Dividend Yield (DY) calculated?

Answer 10

DY = DPS / Share price, expressed as a percentage.

Question 11

What is the Dividend Payout Ratio (DPR)?

Answer 11

DPR = DPS / EPS or Dividends Paid to Ordinary Shareholders / Net Profit.

Question 12

What is the traditional view of dividend policy?

Answer 12

Shareholders prefer dividends now rather than reinvestment for future dividends, as they perceive dividends as more certain.

Question 13

What does the modernist view (Miller and Modigliani) state about dividends?

Answer 13

In perfect markets, the pattern of dividends does not affect shareholder wealth; only investment projects do.

Question 14

What is a homemade dividend?

Answer 14

A cash flow from selling part of a shareholder’s holding instead of receiving a dividend.

Question 15

What is the Residual Theory of Dividends?

Answer 15

Dividends should be viewed as a residual amount after all acceptable investment opportunities have been undertaken.

Question 16

What is the Dividend Irrelevance Theory (MM Theory)?

Answer 16

In a perfect world, a firm’s value is determined solely by the earning power and risk of its assets, not by how it splits earnings.

Question 17

What assumptions does the Dividend Irrelevance Theory rely on?

Answer 17

• Capital markets are frictionless * No transaction costs * Efficiently priced securities * No taxes

Question 18

What is the Dividend Relevance Theory?

Answer 18

There is a direct relationship between a firm’s dividend policy and its market value, supported by the bird-in-the-hand argument.

Question 19

What is the bird-in-the-hand argument?

Answer 19

Investors view current dividends as less risky than future dividends, reducing uncertainty about future cash flows.

Question 20

What is the counter-argument to the bird-in-the-hand fallacy?

Answer 20

• Cash flow risk influences dividend payments * Higher dividends do not reduce firm risk.

Question 21

What is the significance of the Dividend Payment Timeline?

Answer 21

It illustrates the process and timing of dividend announcements and payments.

Question 22

What are the factors determining the level of dividends?

Answer 22

• Maximizing shareholder wealth * Providing sufficient financing

Question 23

Fill in the blank: Dividends may only be paid out of _______.

Answer 23

[accumulated profits]

Question 24

What effect does a higher current dividend have on firm value?

Answer 24

Reduces uncertainty about future cash flows, reducing the cost of capital and increasing firm value.

Question 25

What are the two main counter-arguments against the 'bird-in-the-hand fallacy'?

Answer 25

* The riskiness of a firm’s cash flow influences its dividend payments but increases in dividends will not reduce the risk of the firm. * Firms facing greater uncertainty of future cash flow tend to adopt lower payout ratios.

Question 26

Define a constant payout ratio dividend policy.

Answer 26

The firm pays a fixed percentage of earnings to the owners each period; dividends move up and down with earnings.

Question 27

What is a regular dividend policy?

Answer 27

The firm pays a fixed-dollar dividend each period, increasing the regular dividend only after a sustainable increase in earnings.

Question 28

Describe the low-regular-and-extra dividend policy.

Answer 28

A policy based on paying a low regular dividend, supplemented by an additional ('extra') dividend when earnings are higher than normal.

Question 29

What is an extra dividend?

Answer 29

An additional dividend optionally paid by the firm when earnings are higher than normal or under unusual circumstances.

Question 30

What is the clientele effect?

Answer 30

Different payout policies attract different types of investors but do not change the value of the firm.

Question 31

How does the catering effect influence dividend policy?

Answer 31

Managers will try to cater to the wishes of investors, adjusting dividends based on investor demands over time.

Question 32

What is information signalling in the context of dividends?

Answer 32

Dividends provide information about future earnings, affecting the stock price based on shareholder perceptions.

Question 33

What does the agency cost theory suggest about dividends?

Answer 33

A firm that commits to paying dividends reassures shareholders that managers will not waste their money.

Question 34

What are scrip dividends?

Answer 34

Involves the issue of shares instead of cash payments to shareholders, allowing them to receive additional shares.

Question 35

What are share buybacks?

Answer 35

Occurs when a business buys its own shares, which may be cancelled or held for re-issue.

Question 36

List reasons for share buybacks.

Answer 36

* Supporting the share price * Altering the capital structure * Defence against takeover * Returning surplus funds

Question 37

What is a special dividend?

Answer 37

A larger, one-off dividend paid to all shareholders, similar to a normal dividend.

Question 38

What is the residual theory of dividends?

Answer 38

Dividends should be viewed as the earnings left after all acceptable investment opportunities have been undertaken.

Question 39

What do Miller and Modigliani argue regarding dividends?

Answer 39

They argue in favor of dividend irrelevance in a perfect world without market imperfections.

Question 40

What do Gordon and Lintner advance in their theory regarding dividends?

Answer 40

They advance the theory of dividend relevance, supported by the uncertainty-reducing effect of dividends.

Question 41

True or False: Empirical studies provide clear support for dividend relevance.

Answer 41

False.

Question 42

What is the impact of dividend policy on stock value?

Answer 42

The actions of financial managers and stockholders tend to support the belief that dividend policy does affect stock value.

Question 43

What is the definition of cum-dividend share prices?

Answer 43

Share prices that include the accrued dividend.

Question 44

What is the definition of ex-dividend share prices?

Answer 44

Share prices that exclude the dividend.

Question 45

Fill in the blank: The _______ effect suggests that higher taxes on dividends may lead some investors to prefer firms that retain more earnings.

Answer 45

[clientele]