Question

ch14: 2. Other dividend policy issues

Several factors affect a firm's ability to pay a dividend. Three such factors are described in the table: profitability (an increase in net income), investment opportunities, and capital structure (an increase in the debt ratio). Use the table to indicate how a firm’s ability to pay a dividend is affected by the factors described.(Hint: Consider each factor in isolation, with everything else held the same.)

a: Net income increases.

The ability to pay dividends, (DECREASES OR INCREASES)?

b: More profitable investment opportunities are available.

The ability to pay dividends (DECREASES OR INCREASES)? .

c: The firm increases its debt ratio.

The ability to pay dividends (DECREASES OR INCREASES)?

d:Spandelay Industries Inc. is a typical company that is very concerned with meeting investors’ expectations and keeping investors happy. Its earnings tend to fluctuate from year to year because of the nature of the business the company is in. Which of these statements most likely describes Spandelay Industries Inc.’s dividend policy?

___Spandelay Industries Inc. will be willing to increase its dividend only if it believes that it will be able to maintain the dividend increase in future years.

___Spandelay Industries Inc. will increase its dividends in years when it has high earnings so that it can distribute excess free cash flows to investors, even if it means that the firm will have to reduce its dividend in subsequent years.

Answer 1

1.
Increases because higher net income means more ability

2.
Decreases because funds will be used in investment

3.
Decreases because interest payments will increase

4.
Spandelay Industries Inc. will be willing to increase its dividend only if it believes that it will be able to maintain the dividend increase in future years.