Dividend Policies

Question 1

Theoretical considerations

Answer 1

Residual theory & Irrelevancy theory

Question 2

Residual theory

Answer 2

Dividends are only paid after financing all of the positive NPV projects to maximise shareholder wealth
Then pay out residual cash as dividend

Question 3

Irrelevancy Theory

Answer 3

Companies will always invest in positive NPV projects
Dividends stop funding and more shares need to be released to fund projects Shareholders can fake a dividend by selling shares at a high price caused by the investments

Question 4

Practical considerations (5)

Answer 4

Clientele, Uncertainty, Agency, Tax, Liquidity

Question 5

Clientele

Answer 5

Shareholders only invest based on dividend policy and if this is changed may choose to divest

Question 6

Uncertainty

Answer 6

Cash flow is more certain now and shareholders may decide to sell rather than risk losing their capital

Question 7

Agency

Answer 7

Shareholders may be nervous for directors will act in the own interest
They may sell the shares now to reduce the risk

Question 8

Tax

Answer 8

Capital gains tax is higher than dividend tax

Question 9

Liquidity

Answer 9

Dividend payout may cause cash flow issues