Summary
Much of the discussion in the topic centered on whether dividends and dividend policies are relevant. There are basically two main views on this. One is from the perspective of the academicians who are of the opinion that the dividend policy is separate from the investment and financing decisions of a company and is irrelevant in a perfect world as it does not affect the value of the company and to or the wealth of the shareholders. On the other hand, finance managers may find that their decision pertaining to dividends is inter-related to their investment and financing decisions. In deciding whether to pay dividends, managers would have to consider the investment opportunities available to the company, the long-term plans of the company, the effects of their decision on the company as well as the perceptions of investors. Because we do not live in a perfect world, dividend policy is relevant and will have share repurchases, which allow a company to pay out dividends by way of repurchasing shares.

Self-Assessment ? Activity
1. Which of the following statements is TRUE regarding dividend?
A. Based on the bird-in-hand argument, investors are different between dividends and capital gains.
B. If a company has established a clientele that prefers small dividends, the company is unlikely to adopt a residual dividend policy.
C. The signalling hypothesis is based on the concept that investors prefer current dividends over capital gains.
D. If a company follows a residual method for determining divided payouts, a sudden surge in investment opportunities will result in low dividend payouts for that year.

2. Company D wants to maintains a debt/equity ratio of 0.60 (37.5% debt and 62.5% equity). The company forecasts a net income of RM50,000 for this year. Assume Company D has a capital budget of RM60,000. How much should it pay out in dividends if it follows the residual method?
A. RM12,000
B. RM12,500
C. RM12,750
D. RM13,500

3. If the company follows the residual dividend policy and has an optimal capital budget that will use all of last year’s earnings, the company should pay:
A. no dividends to shareholders
B. dividends but only out of past retained earnings
C. dividends financed by borrowing
D. share dividends

4. In determining the optimum payout ratio, the company has to consider the following factors:
I.  investors preferences for capital gains or dividends;
II. the company’s investment opportunities;
III. the company’s target capital structure; and
IV. the availability and cost of external capital to the company.

A. I and II only
B. III and IV only
C. II, III and IV only
D. All of the above

5. One method that can be used by companies to determine their target dividend payout ratio is the residual method. Companies can set their target payout ratio based on the following steps:
I  determine the company’s optimal capital structure;
II  determine the amount of equity needed to finance that capital budget given the company’s target capital structure;
III  use retained earnings to meet equity requirements to the greatest extent possible; and
IV.  pay dividends only if more earnings are available than are needed to support a company’s  investment needs — i.e. dividends are paid out of excess earnings only.

A. I and II only
B. III and IV only
C. II, III and IV only
D. All of the above