Explain the factors that finance managers should analyse before making a dividend decision.

Advanced Financial Management Block Revision Mock Exams

A company may pay a different dividend from another even if their issued capital is the same because of differences associated with:

• Liquidity of each firm – The more liquid the firm, the higher the dividends other things constant.
• Tax position of shareholders e.g shareholders with low income from other sources will prefer high dividends to supplement their income.
• Profitability of the firm – Other factors constant, the higher the profits, the higher the dividends.
• Bond/debt covenants e.g restrictions of payment of dividends from retained earnings.
• Availability of investment opportunities – The more the projects yielding a positive NPV the higher the retained earnings and the lower the dividends.
• Access the capital markets e.g firms which can easily and cheaply secure debt capital can afford to pay high dividends and vice versa.
• Capital structure decisions – If the firm wants to reduce gearing through increase in equity, retained earnings will be increased thus lower dividends paid.
• Level of business risk – Firms with high volatility of earnings will generally pay low dividends (other factors constant) due to uncertainty of profits and reduced ability to borrow.
• Shareholders expectations – If shareholders have been receiving increasing DPS, the firm would persist on this trend since any reverse trend may affect the market value of shares.

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