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How should investment opportunities influence dividend policy?© BrainMass Inc. brainmass.com October 16, 2018, 4:44 pm ad1c9bdddf
THE EFFECT OF INVESTMENT OPPORTUNITIES ON DIVIDEND POLICIES
While comparing regulated and unregulated firms, we find some interesting results. On average, a regulated firm is less risky; has a lower growth rate; has much fewer insiders holding its common stock; and has fewer investment opportunities, but pays a higher percentage in dividends. Possible explanations for this include the following: while the issue of dividend policy is far more pervasive, we can understand the determinants of dividend payout for firms. Specifically, those concerned with addressing what factors determine the dividend payout rate. Hence, for the purpose our understanding, a firm's dividend policy is proxied by its dividend payout rate, which is defined as the ratio of dividends per share and earnings per share.
Some other issues also affect the dividend payout rate:
Past growth should be an important determinant of the dividend payout rate. In general, a firm would look at its (recent) past growth rate when deciding how much of its earnings it needs to retain (for growth), and how much to give away as dividends.
The decision to pay dividend and the investment opportunities:
Why do firms pay dividends? If they didn't ...
Residual dividend policy and various scenarios
Mary's Mugs is evaluating its dividend policy. What would the differences be with a residual policy vs cash dividends?
Capital budget $10,000,000
Desired capital structure Debt 40% Equity 60%
Expected net income $7,000,000
Outstanding shares 5,000,000
Last annual dividend per share $0.50
1. If the company follows a residual policy, how much will it pay out in dividends?
2. If the company decides to maintain last year's dividend, how much will it pay out in dividends this year?
3. What options are available for the company for raising funds needed for the capital budget?
4. Will it be a good idea for the company follow the residual dividend policy? Why or why not?
5. Which is more profitable for the stockholder, cash dividends or stock repurchases? Why?