Question

Assume that you are on the board of directors for a start-up firm. The firm is expecting small profits and possible losses, but significant growth over the next 10 years. They have asked your opinion on a dividend policy for the firm. Provide your opinion on a dividend policy along with reasoning using terminology discussed in this module. When responding to your peers, select a consideration they may not have thought about pertaining to the dividend policy and explain how it might affect the policy.

Answer 1

The growth company will be requiring cash for its future expansion and retained earnings is one of the best sources of capital for a growth company because the company need not raise any additional capital from the market and there is no fixed payment, unlike debt financing. The growth Company is mainly looking for risk-free/less risky capital due to uncertainty involved in growth (unlike a stable company). retained earnings have the characteristics of common stock, it means they are a less risky source of capital.

As the expected rate of return from a growth company is more than the required rate of return, it will be creating value for the shareholders by non-payment of dividend.

The growth company should retain its earnings instead of distribution in the form of a dividend.