Distribution decisions are complicated and involve the understanding of critical strategic factors that affect the policy and value of a firm. Thus, the management of any firm has to consider the constraints on dividend payments, the availability and cost of alternative sources of capital, and other external factors when they create and implement their distribution policy. Consider the following restriction:
Restrictions on dividend payments based on the liquidity position of the firm.
Based on your understanding of the constraints on dividend payments, identify the type of constraint this condition represents. Assume that all other factors are held constant.
A) Penalty tax
B) Impairment of capital rule
C) Availability of cash
D) Bond indenture
A company’s dividend policy can also be affected by factors internal to the organization and by the external (macroeconomic) environment in which the business operates. In the table that follows, identify which factors, in general, tend to favor high or low dividend payout ratios.
Factor
Favors a High Payout
Favors a Low Payout
Taxes on capital gains are deferred until the capital gain is realized, but taxes on dividend income are due in the year in which the dividends are received.
A firm has limited investment opportunities.
A firm expects to need financing in the future and wants to avoid the risk of dilution associated with the issuance of new shares.
Having the ability to accelerate or delay projects makes it (easier or harder) for a firm to adhere to a stable dividend policy.
A firm with ( lower or greater) flotation costs is more likely to have a high dividend payout ratio.