Alternative dividend policies Over the last 10 years, a firm has had the earning

Question

Alternative dividend policies Over the last 10 years, a firm has had the earnings per share shown in the following table. If the firm's dividend policy were based on a constant payout ratio of 40% for all years with positive earnings and 0% otherwise, what would be the annual dividend for each year? If the firm had a dividend payout of $1.00 per share, increasing by $0. 10 per share whenever the dividend payout fell below 50% for two consecutive years, what annual dividend would the firm pay each year? If the firm's policy were to pay $0.50 per share each period except when earnings per share exceed $3.00, when an extra dividend equal to 80% of earnings beyond $3.00 would be paid, what annual dividend would the firm pay each year? Discuss the pros and cons of each dividend policy described in parts a through c.

Explanation / Answer

The dividends as per the three policies is given below: Dividend year EPS Policy a Policy b Policy c 2006 0.25 0.10 1.00 0.50 50% -0.50 0.00 1.00 0.50 1.5 1.80 0.72 1.00 0.50 2.5 1.20 0.48 1.00 0.50 3.5 2.40 0.96 1.00 0.50 4.5 3.20 1.28 1.00 0.66 5.5 2.80 1.12 1.10 0.50 6.5 3.20 1.28 1.10 0.66 7.5 3.80 1.52 1.10 1.14 8.5 4.00 1.60 1.10 1.30 Pros and Cons of dividend policy: Policy a - constant pay out ratio: The policy is simple and provides for dividend payment at a constant proportion of the EPS. It indicates a stable policy wrt dividends. There won't be any constraint on resources to pay the dividend. The disadvantage is that during low profit periods dividends would be lower, or absent if profit is negative. This would send wrong signals to the market and the share price is bound to fall. Essentialy dividend is a payment from the retained earnings and hence need not be restricted to the curren year EPS. Policy b - a regular dividend policy, with some compensation when the payout ratio is less than 50% for two consecutive years. The dividends do not decrease under the policy and hence the dividend decision gives positive inoformation to the investors. But, here there is no upward movement in the dividend when the EPS is growing; it provides a little relief if dividend is less than 50% of the EPS for two consecutive years. Policy c - a regular dividend policy with higher additional rate for EPS above $3: Provides for higher dividend if the EPS is above $3. Minimum dividend is ensured, but the EPS limit for higher dividend is set high; it could be lowered so that incentive is available at lower levels of EPS.

Related Questions

Navigate

• Browse (All)
• Browse A
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.