Increase in Retained Earnings

Decreased Dividend Policy

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Question

A decrease in a firm's willingness to pay dividends is likely to result from an increase in its ________.

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Explanations

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A. B. C. D. E.

E

Two points must be kept in mind when deciding how much cash should be distributed to stockholders:

1. The main objective is to maximize shareholder value.

2. The cash flows generated by the firm belong to its shareholders.

The optimal payout ratio is a function of 4 factors:

1. Investors' preferences for dividends versus capital gains.

2. The firm's investment opportunities.

3. The firm's target capital structure.

4. The availability and cost of external capital.

The last 3 steps are combined in the residual dividend model, which is a model in which the dividend paid is set equal to the actual earnings minus the amount of retained earnings necessary to finance the firm's optimal capital budget.

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