1. Factors that influence dividend policy

Dividend decisions are complicated and involve the understanding of critical strategic factors that affect the policy and value of a firm. Thus, the management of any firm has to consider the constraints on dividend payments, the availability and cost of alternative sources of capital, and other external factors when they create and implement their dividend policy.

Based on your understanding of the constraints that affect dividend payments, identify the type of constraint described by the following statement:

Restrictions in debt agreements that state the maximum amount of dividends that can be paid in any year

This is a description of:

The capital-impairment restriction

A penalty tax consideration

Restrictive covenants

The insolvency restriction

A companys dividend policy can also be affected by factors internal to the organization and by the external (macroeconomic) environment in which the business operates. In the table that follows, identify which factors, in general, tend to favor high or low dividend payout ratios.

Factor	Favors a High Payout	Favors a Low Payout
Taxes on capital gains are deferred until the capital gain is realized, but taxes on dividend income are due in the year in which the dividends are received.
A firm has limited investment opportunities.
A closely held firm has a majority of its shareholders in high marginal tax brackets.

A firm that can increase its debt ratio without raising its cost of capital sharply is likely to have a stable dividend policy.