Distribution decisions are complicated and involve the understanding of critical
ID: 2719951 • Letter: D
Question
Distribution decisions are complicated and involve the understanding of critical strategic factors that affect the policy and value of a firm. Thus, the management of any firm has to consider the constraints on dividend payments, the availability and cost of alternative sources of capital, and other external factors when they create and implement their distribution policy. Based on your understanding of the constraints on dividend payments, identify the type of constraint this condition represents. Assume that all other factors are held constant. Often stipulates that no dividends can be paid unless the current ratio, times-interest-earned ratio, and other safety ratios exceed stated minimums. Bond indenture Preferred stock restriction Impairment of capital rule Along with several constraints, several internal factors within a company and external macroeconomic factors affect a firm's dividend policy. In the table, identify which factors, in general, tend to favor high or low payout ratios. A company recorded high retained earnings but has very little cash and other liquid assets. Favors a High Payout Favors a Low Payment A firm has an established credit line for access to external sources of funding. Favors a High Payout Favors a Low Payment A firm expects to require funding in the future and wants to avoid the risk of dilution with the issuance of new shares. Favors a High Payout Favors a Low Payment A firm that can adjust its debt ratio without raising its weighted average cost of capital (WACC) sharply is __________ likely to have a stable dividend policy.Explanation / Answer
1) A Bond Identure often stipulates that no dividends can be paid unless the current ratio,times-interest-earned ratio and other safety ratios exceed stated minimums
because Bond Identure is a legal document which states the conditions to be fulfilled by the borrower firm for , the firm to get the loan
2)
a) when a company records high retained earnings but has very little cash, it will most likely have a Low payout ratio since the liquid assets are very less and the the company retained a high portion of earnings since it would require financing for its investments
b) when a firm has an established credit line , it would be easier for it to borrow funds , hence it can afford to follow a High payout policy
c) when a firm expects to require funding in the future and does not want to resort to external finance, it will most likely follow a low payout policy since the firm will use internal funds for its investments
3)
A firm that can adjust its debt ratio without raising its weighted average cost of capital (WACC) sharply is more likely to have a stable dividend policy
since the firm can easily resort to external financing easily, it would not need to retain a large portion of earnings and can afford to pay a high proportion of its earnings as dividends and follow a stable policy