ACCA Applied Knowledge · Business and Technology · Stakeholders in business organisations
A bank has lent heavily to Tolan Co. The directors propose a large special dividend funded by new borrowing. Which statement best explains the likely reaction of the bank?
The bank will be concerned. Lenders want to be repaid with interest, and a special dividend funded by extra borrowing raises gearing and moves cash to shareholders, which increases the risk that the company cannot meet its debt obligations. Lenders gain nothing from dividends or share price rises.
- AThe bank will welcome it, as lenders want the highest possible dividends
- BThe bank will be concerned, as higher gearing and cash leaving the business increase the risk of non-repaymentCorrect
- CThe bank will be indifferent, as lenders are concerned only with the share price
Explanation
Lenders are primarily interested in security, interest payments and repayment. A debt-funded dividend raises gearing and transfers value to shareholders, so repayment risk increases. Lenders do not benefit from dividends and are not focused on share price.
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