Question

How do growth opportunities affect dividend decisions ?​​

Answer 1

• The amount of growth a firm can sustain and its profitability is related to its dividend decisions, so long as the firm (because of managerial imposed to external market constraints) cannot issue additional equity.
• Firms with strong growth prospects maintain low target payout ratios. In fact, all the firms that experience above-average growth rates are expected to have low dividend payout ratios since, in line with the residual theory of dividends, a greater number of profitable investment opportunities should result (other things being equal in a greater need for earnings retention.
• This interrelationship among the firm’s growth, its profitability, and its investment, financing, and dividend decisions cannot be overemphasized.

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Answer 2

( Answer for 5 marks ) The amount of growth a firm can sustain and its profitability is related to its dividend decisions, so long as the firm (because of managerial imposed to external market constraints) cannot issue additional equity.

Firms with strong growth prospects maintain low target payout ratios. In fact, all the firms that experience above-average growth rates are expected to have low dividend payout ratios since, in line with the residual theory of dividends, a greater number of profitable investment opportunities should result (other things being equal in a greater need for earnings retention. This interrelationship among the firm’s growth, its profitability, and its investment, financing, and dividend decisions cannot be overemphasized.

(Answer for 3 - 2marks)

Companies having good growth opportunities retain more money out of their earnings so as to finance their required investments and pay less dividend and vice-versa.