Question

Alternative dividend policies
Over the last 10​ years, a firm has had the earnings per share shown in the following​ table:
a.If the​ firm's dividend policy were based on a constant payout ratio of​ 40% for all years with positive earnings and​ 0% otherwise, what would be the annual dividend for 2016​?

b.If the firm had a dividend payout of​ $1.00 per​ share, increasing by​ $0.10 per share whenever the dividend payout fell below​ 50% for two consecutive​ years, what annual dividend would the firm pay in 2016​?

c.If the​ firm's policy were to pay​ $0.50 per share each period except when earnings per share exceed​ $3.00, when an extra dividend equal to​ 80% of earnings beyond​ $3.00 would be​ paid, what annual dividend would the firm pay in 2016​?

d.Discuss the pros and cons of each dividend policy described in parts a through c.

.. If the firm's Mand policy were based on a constant pay we of 40% for all years with positive warnings and we team din 16 found to the con Det Click on the can b e on the price of the datatable below in order to capy its content is a pre t Earnings per share Year share

Answer 1

(a) Annual Dividend for 2016

Given:

Dividend Payout ratio = 40%

Earnings Per share for 2016 = $2.75

As per the formula,

Dividend Payout ratio = Dividend per share / Earnings Per share x 100

0.4 = DPS / 2.75

hence,

Dividend per share / Annual Dividend for 2016 = $ 1.1

b)

Year	Dividend Per Share	Earnings Per share	Dividend payout ratio
2010	1	0.78	128.21%
2011	1	1.47	68.03%
2012	1	1.19	84.03%
2013	1	1.46	68.50%
2014	1	2.43	41.15%
2015	1	3.94	25.38%
2016	1.1	2.75	40%

In this case the dividend per share for year 2014 and 2015 fell below 50 %, hence as specified in the question the dividend per share for 2016 will be increased by $0.10 that is $1.10 and the payout ratio would be 40%.

c)

Year	Dividend Per Share	Earnings Per share	Dividend payout ratio
2010	0.5	0.78	64.10%
2011	0.5	1.47	34.01%
2012	0.5	1.19	42.02%
2013	0.5	1.46	34.24%
2014	0.5	2.43	20.58%
2015	1.252	3.94	31.78%
2016	0.5	2.75	18.18%

The firm's policy is to pay dividend equal to 80% of earnings beyond $3, else the dividend will be paid as $ 0.5. As shown in the table, earnings per share in 2015 is exceeding $ 3 hence dividend is calculated as (0.5 + (3.94-3) x 0.8) = 1.252. However the earnings per share in 2016 is $2.75 which is below $ 3 as specified in the question,hence the annual dividend in 2016 will be $0.5 only.

d) Pros of constant dividend payout policy

• The amount of dividend payout ratio will be known.
• Regular income for shareholders.

Cons of constant dividend payout policy

• Constant dividend payout will hamper the growth prospects of a growing company.

Pros of second dividend policy

• Regular and high income for shareholders.

Cons of second dividend policy

• A high percentage of dividend payout means that the company is not a growing company which will impact its share prices in future.

Pros of third dividend policy

• The overall dividend payout ratio is reducing with each passing year which means that the company is a growing company.

Cons of third dividend policy

• Decrease in Dividend payout ratio each year might be taken as a negative sentiment by the shareholders which can increase the selling pressure of shares in the market.