Distribution of Earnings

Question 1

What factors affect the dividend policy

Answer 1

Investment Opportunities
Legal Rules ( can’t declare div if insolvent/ if will make company insolvent or due to debt covenants)
Expected Volatility of future earnings and cashflows
Tax position of shareholders

Question 2

What is residual dividend policy

Answer 2

Dividends paid on earnings less funds retained to finance the equity portion of the capital budget

Question 3

What is the advantage of residual dividend policy

Answer 3

Allows to pursue profitable investment opportunities without being constrained by dividend considerations

Question 4

What is the disadvantage of the residual dividend policy?

Answer 4

Unstable dividends that fluctuate

Question 5

What are alternatives to cash dividends?

Answer 5

1. Stock Dividends
2. Stock Splits
3. Share Repurchase
4. Dividend Reinvestment

Question 6

What are stock dividends?

Answer 6

Paid with new shares than cash

market value doesn’t change though the share structure and ownership may change

Question 7

What are stock splits?

Answer 7

Increase in the number of shares of a class of capital stock

Question 8

What is a share repurchase

Answer 8

buyback its own share
Done when typically undervalued
increases EPS as fewer shares are outstanding
Promotes future flexibility

Question 9

What is dividend reinvestment

Answer 9

Provides an opportunity for shareholders to use cash dividends to acquire more shares in the company