Distribution 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 distribution policy.

Consider the following restriction:

Restrictions on dividend payments based on the liquidity position of the firm.

Based on your understanding of the constraints on dividend payments, identify the type of constraint this condition represents. Assume that all other factors are held constant.

Availability of cash

Impairment of capital rule

Penalty tax

Bond indenture

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
A firm has several investment opportunities and limited internal cash flow generation.
A firm has a history of stable earnings and expects earnings stability in the future.
In an inflationary environment, a firm has to increase its cash balances to meet the rising prices of its inventory, wages, and other short-term liabilities.

When a firm has a large number of profitable investment opportunities, it will usually have a target payout ratio.

If management is concerned with keeping control of the company, it will be likely to retain earnings than it otherwise would to avoid diluting control by issuing new stock to raise capital.