302919 Dividend Payout Ratio 1F

Question 1

All of the following are true except:

a growth company would probably have a low dividend payout ratio since it would want to retain funds to support growth. However, a mature organization would probably have a relatively high payout ratio due to the fact that it would want to compensate its stockholders for a lower stock appreciation rate and might have fewer opportunities for new investments within the firm.

a dividend payout ratio greater than 100% would attract investors interested in immediate cash flow from their investments.

the dividend payout ratio is an indication of the company’s commitment to the payment of dividends to the investor group as well as the commitment to investment in possible high-return projects.

the net income figure used in the dividend payout ratio needs to be adjusted for any preferred dividends that were paid during the period.

Answer 1

a dividend payout ratio greater than 100% would attract investors interested in immediate cash flow from their investments.

Growth companies do tend to retain a larger percentage of income for investment in their organization while mature companies tend to have a higher dividend payout ratio to compensate their stockholders for a lower stock appreciation rate and/or lower availability of profitable investment projects.

The formula for the dividend payout ratio is Cash dividends paid on common stock ÷ (Net income - Preferred dividends).

A company that paid out more than 100% of net income as cash dividends is paying out dividends with funds that were not provided by operations. More than likely an organization could not keep up the payment of such dividends for any length of time; therefore, most investors who desired good cash flow from their investment would not be interested in purchasing stock in such an organization.

Question 2

Cash Dividend

Answer 2

A cash dividend is the distribution of cash to stockholders in proportion to the number of outstanding shares held. Accounting for dividends involves a disbursement (credit) from the cash account and a reduction (debit) to Retained Earnings.

The entry to record would be:

 When declared:  DR  Retained Earnings     xx
                 CR    Dividends Payable        xx
       or
                 DR  Dividends Declared    xx
                 CR  Dividends Payable          xx

 When paid:      DR  Dividends Payable     xx
                 CR    Cash                     xx If a corporation uses the temporary account Dividends Declared, it is closed to Retained Earnings at the end of the accounting year.

A cash dividend represents a return on investment to shareholders.

Question 3

Common Stock

Answer 3

Common stock is ownership interest that is subordinate to all other classes of stock (and to all creditors) of the issuing corporation in participation rights and in dividend and liquidation preferences (i.e., holders of common stock are paid after debt and preferred stock obligations have been met). Common stock is also known as residual ownership interest and usually carries voting rights (at stockholders’ meetings), although some classes of common stock may be nonvoting. Common stock is often called common shares.

Question 4

Dividend Payout Ratio

Answer 4

The dividend payout ratio is the percentage of earnings paid out to shareholders in cash, calculated as:

• Dividend per share ÷ Earnings per share or
• Dividends ÷ Net income.

Question 5

Net Income

Answer 5

Net income is operating income plus non-operating revenues minus non-operating expenses minus taxes.

Question 6

2163.03

Answer 6

Dividend yield

The dividend yield ratio shows the return to the stockholder based on the current market price of the stock.

Dividend yield = Dividend per common share / Market price per common share

Dividend payments to stockholders are subject to many variables. The relationship between dividends paid and market prices is a reciprocal one.
This ratio is calculated using the current market price; however, most of the shareholders did not purchase their shares at the current price, thus making their personal yield different than the calculated yield.
Calculation using data from the Sample Company for 20X2 (section 2160.01):

Dividend yield = Dividend per common share
Market price per common share

            = $10,000 ÷ 20,000 shares
                  $17.00 per share

            = 2.9%

Question 7

2163.04

Answer 7

Payout ratio to common shareholders

The payout ratio to common shareholders measures the portion of net income to common shareholders that is paid out in dividends.

Payout ratio to common shareholders = Common dividends / (Net income – Preferred dividends)

Income does not necessarily measure cash available for dividend payment. Payments are heavily influenced by management policy, the nature of the industry, and the stage of development of the particular firm. All of these items diminish comparability between companies.
Organizations that have high growth rates generally have low payout ratios since most earnings are kept as retained earnings with the funds being reinvested in the company instead of providing cash dividends. A firm that has consistently paid a dividend and suddenly lowers its dividend payout often is signaling a lack of available cash and the existence of liquidity or solvency problems.
Calculation using data from the Sample Company for 20X2 (section 2160.01):

Payout ratio to common = Common dividends
shareholders Net income – Preferred dividends

                     =      $10,000     
                       $75,000 – $15,000

                     = 16.67%