ACCA Strategic Professional · Advanced Financial Management · Financial strategy formulation
Which of the following is the most appropriate description of a conflict between the dividend decision and the investment decision for a multinational's financial strategy?
Paying large dividends cuts retained earnings available for positive-NPV investment, which may force the company to raise more expensive external finance or reject worthwhile projects. This is the real tension between the dividend and investment decisions, whereas the other statements are absolute and incorrect.
- APaying large dividends reduces retained earnings available for positive-NPV projects, so internal funds may need replacing with costlier external financeCorrect
- BPaying dividends always increases the cost of equity
- CInvesting in positive-NPV projects always reduces shareholder wealth in the short term
- DDividends are irrelevant in every circumstance
Explanation
Retained earnings are the cheapest and most accessible source of finance for investment. A high payout can force the company to raise external funds, incurring issue costs and possibly a higher cost of capital, or to forgo positive-NPV projects. The other options state absolute claims that are not supported by theory.
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