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Dividend Policy and Price-Earnings Ratio

For each of the following four groups of companies, state whether you would expect them to distribute a relatively high or low proportion of current earnings and whether you would expect them to have a relatively high or low price-earnings ratio.

a. High-risk companies.
b. Companies that have recently experienced a temporary decline in profits.
c. Companies that expect to experience a decline in profits.
d. 'Growth' companies with valuable future investment opportunities.

'Risky companies tend to have lower target payout ratios and more gradual adjustment rates.' Explain what is meant by this statement. Why do you think it is so?

Solution Preview

For each of the following four groups of companies, state whether you would
expect them to distribute a relatively high or low proportion of current earnings and whether
you would expect them to have a relatively high or low price-earnings ratio.
a. High-risk companies.
b. Companies that have recently experienced a temporary decline in profits.
c. Companies that expect to experience a decline in profits.
d. 'Growth' companies with valuable future investment opportunities.

a. High-risk companies.
Payout: Distribute Low proportion of current earnings; high risk ...

Solution Summary

The solution provides answers to 2 questions
The first problem deals with the dividend policy likely to be followed by High-risk companies, Companies that have recently experienced a temporary decline in profits, Companies that expect to experience a decline in profits and 'Growth' companies with valuable future investment opportunities.
The second problem discusses why Risky companies tend to have lower target payout ratios and more gradual adjustment rates.

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