Question

Ananta Ltd. is a company dealing in ready-made garments from last many years. Recently the profit of the company have started increasing. The finance…

Accepted Answer

(i) Dividend Decision Dividend decision is concerned with the decision about how much of the profit earned by company is to be distributed to the shareholders and how much of it should be retained in the business. (ii)Factors affecting dividend decision are: (a) Amount of earnings: Earnings is a major determinant of the decision about dividend as dividends are paid out of current and past earnings. (b) Stability of Earnings: A company which has stable earnings is in a better position to declare higher dividends in comparison of those companies with unstable earnings. (c) Stability of Dividends: The companies having policy of stabilizing dividend per share, do not alter if the change in earnings is small or seen to be temporary in nature. (d) Growth Opportunities: Companies having good growth opportunities retain more money out of their earnings to finance the required investment, therefore, the dividend in growth companies is smaller than that in the non–growth companies. (e) Cash Flow position: Availability of enough cash in the company is necessary for declaration of dividend because a company may be profitable but short on cash. (f) Shareholders’ Preference: While declaring dividends, managements must keep in mind the preferences of the shareholders and if the shareholders in general desire that at least a certain amount is paid as dividend, the companies are likely to declare the same. (g) Taxation Policy: If tax on dividend is higher, it is better to pay less by way of dividends, whereas higher dividends may be declared if tax rates are relatively lower. (h) Stock Market Reaction: The possible impact of dividend policy on the equity share price is one of the important factors considered by the management while taking a decision about it as investors, view an increase in dividend as good news and stock prices react positively to it. (i) Access to the capital market: Large and reputed companies which have easy access to the capital market, depend less on retained earnings to finance their growth and, thus, tend to pay higher dividends than smaller companies which have relatively low access to the market. (j) Legal constraints: Certain provisions of the Companies Act place restrictions on payouts as dividend which must be adhered to while declaring the dividend. (k) Contractual constraints: The companies are required to ensure that the payment of dividend does not violate the terms of any contract entered by the company. OR (i) Financing Decision. The Financing Decision is concerned with the decisions about the quantum of finance to be raised from various long-term sources. (ii) Factors affecting Financing Decision: (a) The cost of raising funds through different sources are different and a prudent financial manager would normally opt for a source which is the cheapest. (b) The risk associated with each of the sources is different as debt is riskier than equity. (c) Higher the floatation cost, less attractive the source. (d) A stronger cash flow position may make debt financing more viable than funding through equity. (e) If a business has high fixed operating costs, it must reduce fixed financing costs, thus, lower debt financing is better. (f) Issue of more equity may lead to dilution of management’s control over the business while debt financing has no such implication. (g) State of the capital market may also affect the choice of source of fund as during the period when stock market is rising, more people invest in equity, whereas depressed capital market may make issue of equity shares difficult for any company.

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