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CMA Intermediate · Financial Management and Business Data Analytics · Dividend Decisions and Dividend Theories

A profitable Indian manufacturing company has signed a term-loan agreement that bars it from paying dividends beyond 30% of annual profit until the loan is repaid. Which factor affecting dividend policy does this illustrate?

This illustrates legal and contractual restrictions. Lenders often put covenants in loan agreements that cap dividends to protect their repayment security, so the company must follow the limit even though it is profitable and could otherwise distribute more to its shareholders.

  1. ALegal and contractual restrictionsCorrect
  2. BShareholders' tax status
  3. CStability of earnings
  4. DAccess to the capital market

Explanation

A loan covenant limiting dividend payout is a contractual restriction imposed by lenders. It limits the amount that can be distributed irrespective of profits or shareholder preferences. Tax status, earnings stability and capital market access are separate factors not described here.

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