Dividend Decision: Dividend Theories, Policies and Factors Affecting Dividend (Overview) Questions

Question 1

Define dividend decision.

Accepted Answer

Dividend decision is deciding the portion of profit to distribute as **dividend** and the portion to **retain** in the business (concept).

Question 2

What is dividend payout ratio? (concept)

Accepted Answer

Dividend payout ratio = Dividend / Earnings (profit available to shareholders) (concept).

Question 3

Retention ratio is the portion of earnings retained. (True/False)

Accepted Answer

True. **Retention ratio** is the portion of earnings retained for reinvestment (concept).

Question 4

State one factor affecting dividend policy.

Accepted Answer

**Liquidity/cash availability** (or profitability, growth opportunities, etc.) (concept).

Question 5

Residual dividend policy means dividend is paid after meeting investment needs. (True/False)

Accepted Answer

True. Under **residual** policy, earnings are first used for investments; remaining earnings are paid as dividend (concept).

Question 6

Name one dividend theory (concept).

Accepted Answer

Walter’s model / Gordon’s model / **MM dividend irrelevance** theory (any one) (concept).

Question 7

List any three dividend policies using points.

Accepted Answer

Any three dividend policies (concept):

- **stable dividend** policy
- constant payout ratio policy
- residual dividend policy
- irregular/variable dividend policy

Any three with brief meaning are sufficient.

Question 8

Differentiate dividend payout ratio and retention ratio using a small table.

Accepted Answer

Payout vs retention (concept):

| Ratio | Meaning |
|---|---|
| **Payout ratio** | dividend / earnings |
| **Retention ratio** | retained earnings / earnings |

Relation: payout + retention = 1 (concept).

Question 9

List any three factors affecting dividend policy and explain briefly.

Accepted Answer

Factors (any three):

- **profitability** and stability of earnings
- **liquidity** / cash availability
- growth opportunities (need to retain funds)
- access to external finance (concept)
- shareholder expectations (income preference) (concept)

Any three with brief explanation are sufficient.

Question 10

Differentiate relevance and irrelevance theories of dividend using a table (brief).

Accepted Answer

Relevance vs irrelevance (concept):

| Point | **Relevance** (Walter/Gordon) | **Irrelevance** (MM) |
|---|---|---|
| Claim | dividend affects value | dividend does not affect value (under ideal assumptions) |
| Key idea | investor preference / r vs k (concept) | value driven by investment policy/earnings |
| Assumptions | less strict | strict perfect market assumptions (concept) |

Thus, relevance theories link dividend policy to value; MM denies it under ideal conditions.

Question 11

Explain stable dividend policy and why firms prefer it (any three points) using a small table.

Accepted Answer

Stable dividend policy:

| Point | Explanation |
|---|---|
| Meaning | dividend per share is kept **steady** over time |
| Investor confidence | provides predictable income; reduces uncertainty (concept) |
| Market signalling | stability signals confidence in future earnings (concept) |

Thus, firms prefer stable dividends to support investor expectations and market reputation (concept).

Question 12

Write an exam-style answer on dividend decision: meaning, importance and factors (include a table and conclusion).

Accepted Answer

### Meaning
**Dividend decision** is payout vs retention of earnings.

### Importance
- affects shareholder income and expectations
- impacts **liquidity** (cash outflow)
- influences growth financing through retained earnings (concept)

### Factors (table)
| Factor | Effect (concept) |
|---|---|
| **Profit stability** | stable profits support stable dividends |
| **Liquidity** | low cash may reduce dividend |
| Growth opportunities | high growth → higher retention |

### Conclusion
A sound dividend policy balances shareholder return with liquidity and long-term growth needs (concept).

Question 13

Explain Walter’s model (concept) and its implications when r > k and r < k (exam-style) with a table and conclusion.

Accepted Answer

### Core idea (concept)
Walter links dividend policy to value based on return on investment (**r**) vs cost of equity (**k**).

| Condition | Implication for dividend policy (concept) |
|---|---|
| **r > k** | retain more (reinvestment earns more than required) |
| **r < k** | pay more dividend (retaining earns less than required) |
| r = k | dividend policy neutral (concept) |

### Conclusion
Walter suggests dividend policy is relevant because reinvestment return relative to required return changes the best payout decision (concept).

Question 14

Explain MM dividend irrelevance theory (concept) with assumptions and conclusion (exam-style) using a table/flow.

Accepted Answer

### Statement (concept)
MM argues dividend policy does not affect firm value under ideal market conditions.

| Assumption (concept) | Meaning |
|---|---|
| No taxes / no transaction costs | investors can adjust cash flows easily |
| Perfect markets | no information advantage |
| Fixed investment policy | investment decisions are unchanged |

### Conclusion
Under these assumptions, value depends on earnings and investments, not on how earnings are split into **dividend vs retention** (concept).

Question 15

Draw a dividend decision framework flowchart (earnings → investment needs → retention → payout) and explain briefly.

Accepted Answer

Dividend decision framework (flow):

Earnings available → Investment needs → Target financing mix (concept) → Decide **retention** → Decide **dividend payout** → Ensure liquidity/compliance (concept)

Briefly, firms pay dividends after ensuring funds for growth and maintaining cash availability.

Dividend Decision: Dividend Theories, Policies and Factors Affecting Dividend (Overview)

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