Answer to Question #275757 in Economics of Enterprise for UMAIR

Question

As an investor, would you rather invest in a firm that has a policy of maintaining (1) a constant payout ratio, (2) a stable, predictable dividend per share with a target dividend growth rate, or (3) a constant regular quarterly dividend plus a year-end extra payment when earnings are sufficiently high or corporate investment needs sufficiently low? Explain your answer, stating how these policies would affect your required rate of return, rs. Also, discuss how your answer might change if you were a student, a 50-year-old professional with peak earnings, or a retiree.

Answer 1

Here, the decision would have to be made on an individual basis In our opinion, investors who intend to invest in companies that maintain a relatively high payout probably are seeking income and would accept to receive a stable, or predictably increasing, dollar dividend per share. Thus, for these investors their required retum would comprise of a fairly stable dividend yield plus a relatively low capital gains yield. Investors who are not seeking current income apparently would, over the long run, seek companies that retain a relatively large percentage of their earnings These investors probably would not be particularly concerned about whether the company paid a stable dividend. They would, of course, be concerned with earnings and the trend in earnings Therefore, for these investors their required return would consist of a high capital gains yield and a low dividend yield. When comparing these situations, one would expect a lower r, for the relatively stable, or predictably increasing, dollar dividend per share than for the situation where the company did not pay a stable dividend A retiree probably would need current income and would choose a firm with a constant, or increasing dollar dividend per share A 50-year-old professional with peak earnings would have less need for current income and would choose a firm with a low payout rate.