Dividend Policy

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(Relevant to Paper II – PBE Management accounting and finance) Simon S P Lee, The Chinese University of Hong Kong

Dividend Policy
Bank distributed a $6.30 dividend per share in 2008. If you purchased shares in Hang Seng Bank at $87 per share, the company’s dividend yield was 7.2% ($6.30/$87) which is much higher than the bank deposit rate. Dividend payout ratio is another important indicator: Dividend payout ratio = Dividend per share ÷ Earnings per share

Dividend policy is the policy used by a company to decide how much it will

pay out to shareholders in dividends. In your financial accounting course, you learn that after deducting expense from the revenue, a company generates profit. Part of the profit is kept in the company as retained earnings and the other part is distributed as dividends to shareholders. From the share valuation model, the value of a share depends very much on the amount of dividend distributed to shareholders. Dividends are usually distributed in the form of cash (cash dividends) or share (share dividends which are beyond the remit of this article). When a company distributes a cash dividend, it must have sufficient cash to do so. This creates a cash flow issue. Profit generated may not be in the form of cash. You may verify this by looking at the cash flow statement of a company. A company may have profit of $400 million but the cash only increase by $190 million in a financial year. This is a concern to the management as insufficient cash may mean the company is unable to distribute a dividend. Investors earn returns from their shares in the form of capital gains and dividend yield. Dividend yield is an important ratio in evaluating investment. For example, Hang Seng

This ratio indicates how much of the profit is distributed as dividend to shareholders. The higher the dividend payout ratio, the more attractive the share is to shareholders. Dividend payout ratios vary among companies. The following table...
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