Dividend Policy Essay

4195 Words Mar 25th, 2011 17 Pages
This report focuses on the concept of Dividend Policy used in a firm. It talks about the importance of using a Dividend Policy which is giving a share to the stockholders. A dividend policy is first known as a heavy factor in a company’s stock value and is a set of company rules and guidelines used to decide how much the company will pay out to its shareholders. The report then highlights the common theories and models used in dividend policy decision in an organization. The feasibility of the concept had been further exemplified with the case study of City Lodge Hotels Limited and Microsoft vs Berkshire Hathaway which depicts two companies that do not believe in using a dividend policy and a lodging company that believes in
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Dividend policy can also provide information to the stockholder concerning the firm’s performance. Dividends are usually distributed in the form of cash (cash dividends) or share (share dividends). When a company distributes a cash dividend, it must have sufficient cash to do so. This creates a cash flow issue. Profit generated may not be in the form of cash. This can be verified by looking at the cash flow statement of a company. A company may have a profit of $400 million but the cash only increases by $190 million in a financial year. This is a concern to the management as insufficient cash may mean the company is unable to distribute a dividend. Investors earn returns from their shares in the form of capital gains and dividend yield. Dividend yield is an important ratio in evaluating investment. For example, Hang Seng Bank distributed a $6.30 dividend per share in 2008. If you purchased shares in Hang Seng Bank at $87 per share, the company’s dividend yields was 7.2% ($6.30/$87) which is much higher than the bank deposit rate.
Dividend payout ratio is another important indicator:
Dividend payout ratio = Dividend per share / Earnings per share

This ratio indicates how much of the profit is distributed as dividends to shareholders. The higher the dividend payout ratio, the more attractive the share is to the shareholders.
Dividend payout ratios vary among

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