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Dividend Decisions

By on April 15, 2010

Financial Management for a company involves taking certain key financial decisions for the firm. Of course the basic objective (theoretically atleast) for every company is to maximize its stockholder’s wealth. Key decisions for any firm can be broadly classified as those taken for the long term benefit of the corporate and those taken for the short term.

Long term financial decisions include capital investment issues and short term decisions include those related to the day to day assets and liabilities or in short known as the working capital decisions.

This article is more about a part of the long term decisions of the company
. It is indeed a herculean task to decide about capital and its investment. How to finance the long term objectives of the company (financing decision)? Whether to go for equity or debt or a mix of both. What to do with the profits of the business? How should it be invested in projects (capital budgeting decisions)?

Or should the management pay this profit as dividends to its stockholders (dividend decisions)? A good dividend decision helps in the market performance of a company and that itself is enough to understand the importance of this decision.

Dividend decisions are related to the corporate objectives of increasing the stockholders net worth.
It involves giving back the stockholder the excess profit in the form of dividends. This is not as simple as it sounds. If at all it is agreed to give dividend to its stockholders,

the management has to calculate the rate at which dividend has to be paid and the form in which dividend has to be paid. Form of dividend means it can be paid either as cash or as stocks. For dividends in the form of cash, stockholders may have to pay tax on the dividend.

There are certain factors which affect the dividend decisions such as the availability of free cash flow, market reactions and the type of stock holders it has. Free cash flow means that a company takes part in dividend declaration only after making sure it has enough free cash flow after meeting all its investment needs.

Market reaction, as has been stated earlier, means that the company management has to study the effect its dividend decision will have on its stock price in the market. And finally the company has to study what type of dividend needs to be issued to the different types of stock holders it has. Sometimes not all stock holders get the dividend and only a preferred few get it. And sometimes all the stock holders receive the same.

Not all stock holders can dream of getting dividends even after the company makes a profit. There is a certain class of funds known as growth funds, where the company even after making a profit ploughs it back for growth rather than paying dividend to its stock holders.

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