Chartered Financial Analyst Level 2
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- All else equal, which of the following factors is most likely to result in a decrease in the dividend payout ratio?
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A
A decrease in flotation costs
B
A decrease in the volatility of earnings
C
An increase in profitable investment opportunities
Explanation:
Explanation
An increase in profitable investment opportunities is most likely to decrease the dividend payout ratio because:
- Companies with more positive NPV projects will retain more earnings to fund these investments
- This follows the residual dividend policy where dividends are paid from earnings left after funding all positive NPV projects
- Higher investment opportunities increase the opportunity cost of paying dividends
Other options:
- Decrease in flotation costs makes external financing cheaper, potentially allowing higher dividends
- Decrease in earnings volatility typically allows for higher and more stable dividends
This reflects the pecking order theory where companies prefer internal financing for investments.
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