Page 189 - 5.2 i. Manac Finance ITC Summarised Notes

THE DIVIDEND DECISION

Purpose of a dividend policy

• Investor returns consists of both capital gains and dividend returns.

What is dividend policy?

A strategy developed by a company’s directors for the level of dividends
they will pay each year. Dividend policies differ from company to company.

• Stable dividend that is sustainable in the long term. It may be expressed
in terms of a desired growth rate (i.e. 5% growth per annum), or

• Dividends may be expressed as a cover ratio or payout ratio (dividends
are a constant % of earnings and will fluctuate with any change in
earnings).

Shareholders view a fluctuating dividend policy as more risky than stable
dividends which they are more likely to receive. Therefore shareholders
require a higher return from firms with fluctuating dividends.

Hence, the cost of capital of companies with a stable dividend policy is
lower.

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