Module 12

Question 1

What is the signalling hypothesis?

Answer 1

Dividends are regarded as communicating a message about managements view of current and future profitability.

Question 2

Describe the features of a no dividend policy?

Answer 2

all profits reinvested by company
shareholders may be unhappy as they receive no income
possible tax advantage, cap gains are taxed lower than dividend income

Question 3

Describe the features of a constant divided growth policy?

Answer 3

grows at x per year
predictable
concerns if dividend growth doesn’t match profit growth

Question 4

Describe the features of a constant payout ratio policy?

Answer 4

e.g. percentage of profits

investors unhappy if profits fall

Question 5

Describe the features of a 100% dividend payout policy?

Answer 5

tax disadvantage for investors

implies investors can invest money more profitably than company.

Question 6

what does Walters model state?

Answer 6

RELEVANCE THEORY
If the rate of return is greater than the cost of capital, all profits should be retained.
BUT, if if cost of capital exceeds rate of return, 100% of dividends

Question 7

What are the assumptions of Walter’s model?

Answer 7

• retained earnings are the only source of finance
• cost of capital and rate of return are constant
• life of a company is endless

Question 8

What does the residual theory state?

Answer 8

IRRELEVANCY THEORY
A company should retain whatever profits it needs to fund upcoming investments and projects and then distribute remaining.
Dividends can be volatile under this method
Share price should stay constant, get dividend now or appreciation later from capital investment.

Question 9

What does the MM theory on dividend policy state?

Answer 9

Investor wealth is unaffected by dividend policy.