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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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