Question

VK Ltd. is a fast-moving consumer goods company. It has shareholders spread all over India. Most of its shareholders depend upon a regular income from their investment. VK Ltd. has been earning consistent profits. The management of the company keeps in mind the preference of the shareholders regarding the payment of dividends. Since its shareholders, in general, desire that at least a certain amount is paid as a dividend to them every year, the company declares a dividend every year. Atul, the Finance Manager of the company identified promising growth opportunities. He suggested to the Chief Executive Officer to retain the earnings to finance the required investments instead of declaring a dividend every year. For this, the Chief Executive Officer decided to call a General Body Meeting of the shareholders.
(i) Identify two factors affecting the dividend decision discussed above.
(ii) State two other factors that affect the dividend decision of a company.

Hint:

Dividend decisions are influenced by various factors like shareholder preferences, profitability, growth opportunities, and liquidity.- Companies must balance between rewarding shareholders with dividends and reinvesting earnings for future growth.- A good dividend policy aligns the interests of the company with those of its shareholders and supports long-term business objectives.

Answer 1

(i) Factors Affecting Dividend Decision Discussed:

Shareholders' Preferences: The statement mentions that "Most of its shareholders depend upon a regular income from their investment" and that "The management of the company keeps in mind the preference of the shareholders regarding the payment of dividends." This explicitly highlights the importance of considering shareholders' preferences when making dividend decisions. A company with a large base of income-dependent shareholders often prioritizes consistent dividend payouts.

Stability of Earnings: The statement mentions that "VK Ltd. has been earning consistent profits." Companies with a history of stable and predictable earnings are more likely to declare regular dividends. The stability of earnings provides the company with the financial confidence to commit to consistent dividend payments.

(ii) Other Factors Affecting Dividend Decision:

Here are two other factors that influence a company's dividend decision:

Growth Opportunities: The presence of attractive investment or growth opportunities within the company significantly influences the dividend decision. If the company has promising projects or expansion plans, it may choose to retain a larger portion of its earnings to fund these opportunities, resulting in lower dividend payouts. The trade-off is between providing immediate returns to shareholders (through dividends) and reinvesting earnings for future growth.

Cash Flow Position: A company's cash flow position is a crucial determinant of its ability to pay dividends. Dividends are paid out of the available cash reserves of the company. Even if a company has substantial retained earnings, it may not be able to declare high dividends if its cash flow is tight due to other financial obligations or operational needs.