Dividend Policy Is It Much Ado About Nothing? It was the end of the fourth quart
ID: 2812011 • Letter: D
Question
Dividend Policy Is It Much Ado About Nothing? It was the end of the fourth quarter. The financial statements had been prepared and circulated to the directors of The New Wave Corporation (see Tables 1 and 2). The firm's revenues had surpassed the previous quarter's revenues by over 20% and the annual sales were approximately 15% higher as well. More importantly, the net income figures for the year were up by more than 25%. The restructuring and cost cutting seemed to have paid off. Needless to say, the mood at the corporate headquarters in Dallas, Texas was upheat and full of cheer This year's performance ended a long streak of "down" years and mounting losses. The big question weighing heavily on everyone's minds was "When they ever pay a dividend?" That exactly was to be the main topic of discussion at that day's meeting of the board of directors Edwin Rosewood, a retired biochemist, founded The New Wave Corporation, approximately 12 years ago in his hometown ofExplanation / Answer
1..When a company pays does not pay any dividend , it it will be construed by the market to be a sign that the company is undergoing some financial crisis or all is not well with the company's finances. No dividend or skipping dividend sends a negative signal about the company. The positive side of not giving dividends is that the company's profits can be used for other developmental purposes like expansion of facilities or purchase of better equipment.Retained money is available without flotation costs. But the investors will take this in right spirits ,in the initial years , but not as a regular phenomenon. 2. YES. Dividend paying stocks are more attractive to investors .As more & more investors buy the stock , the prices rise. If dividends are lowered , the demand for stocks decrease , as the investors take it as a signal of financial difficulty & hence stock prices go down. 3.. When a company pays no dividends, a shareholder can create his own homemade dividends, by selling a part of his shares. The shareholder needs to have a cash inflow of $ 1000*0.25= 250 as dividends. In this case,as the company retained all its retained earnings & paid no dividends, he will sell $ 250 worth of shares to create this cash inflow , by himself. 4..Composition of shareholder groups does have a say in the type of dividend policy to be adopted by a company ---as the expectations of different groups may be different. Individuals form the major part of New Wave's capital structure. So, the New Wave would do well to adopt a Stable dividend policy which provides a steady and predictable amount of dividend- payouts year after year , which an individual investor may choose.This is irrespective of the company's earnings- high or low for that year. This model gives the individual shareholder , the certainty about the amount and timing of the dividend. 5.. Residual dividend policy Under this policy, the company distributes as dividends, whatever remains after meeting its capital expenditures and working capital. 6.A strict residual dividend policy results in varying amounts of dividends being distributed each dividend period , rendering the investors with mixed & misleading signals about the financial health of the company.As a result , investors seek higher required rate of return to compensate for the uncertainty. In contrast to the above, in practice, most of the firms decide the dividend % & $ amounts & the residue is the retained earnings --which the firm can use for its capital projects , at nil borrowing costs--but it has opportunity cost of better investment opportunity lost.