CA Intermediate · Financial Management and Strategic Management · Dividend Decision
A company's board decides to pay dividends from a fixed percentage of each year's profit rather than a fixed rupee amount. Which dividend policy is this, and what is its main drawback?
Paying a fixed percentage of profit each year is the constant payout ratio policy. Its main drawback is that dividends vary directly with earnings, so they become uncertain and can fall sharply or disappear in poor years, unlike a stable dividend policy.
- AStable dividend policy; it ignores profits
- BResidual dividend policy; it needs external funds
- CConstant payout ratio; dividends fluctuate with earningsCorrect
- DNo dividend policy; it harms liquidity
Explanation
Paying a fixed percentage of profit is the constant payout ratio policy. Because dividends move in proportion to earnings, they fall when profits fall, and may be nil in loss years. This makes dividends unstable, unlike a stable rupee dividend policy.
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