Dana and David, two young financial analysts, were reviewing financial statements for Compaq, one of the world's largest manufacturers of personal computers. Dana noted that the company did not report any dividends in the Financing Activity section of the statement of cash flows and said, "Just a few years ago, Forbes magazine named Compaq as one of the best performing companies. If it's so good, I wonder why it isn't paying any dividends." David wasn't convinced that Dana was looking in the right place for dividends but didn't say anything.

Dana continued the discussion by noting, "When Forbes selected it as a best performing company, Compaq's sales doubled over the previous two years just as they doubled over the prior two years. Its income was only $789 million that year compared with $867 million the previous year, but cash flow from operating activities was $943 million compared to an outflow of $101 million the prior year." At that point, David noted that the statement of cash flows reported that Compaq had invested S703 million in new property this year compared with $408 million the prior year. He also was surprised to see that inventory and accounts receivable had increased by $1 billion and nearly S2 billion, respectively, the previous year. "No wonder it can't pay dividends; it generated less than SI billion from operating activities and had to put it all back in accounts receivable and inventory."

Required: 1. Correct any misstatements that either Dana or David made. Explain. 2. Which of the factors presented in the case help you understand Compaq's dividend policy?