‘While granting loans to a company, sometimes the lender may impose certain restrictions on the payment of dividends in future.’
The factor affecting dividend decision discussed above is
‘While granting loans to a company, sometimes the lender may impose certain restrictions on the payment of dividends in future.’
The factor affecting dividend decision discussed above is
Show Hint
- Access to capital market
- Contractual constraints
- Legal constraints
- Stock market reaction
The Correct Option is B
Solution and Explanation
The statement says a lender may put restrictions on dividend payments while granting a loan.
The company agrees to these limits in the loan terms.
So the limit arises from an agreement.
Step 2: Identify the factor:
Restrictions that a lender includes in a loan agreement are called contractual constraints.
They protect the lender by keeping cash in the business until the loan is repaid.
Hence option (B) Contractual constraints is correct.
Step 3: Check option (A) Access to capital market:
This is the ease with which a company can raise funds from the market. A company with easy access can pay more dividend.
It has no link with a lender setting limits. So (A) is wrong.
Step 4: Check options (C) and (D):
(C) Legal constraints come from the Companies Act, not from a loan agreement.
(D) Stock market reaction is the effect a dividend decision has on share prices.
Both are wrong.
Final Answer:
The factor discussed is contractual constraints, option (B).
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‘Quality Foods Ltd.’, a company manufacturing packaged snacks has been in business for the last 10 years. It enjoys a good reputation and has a loyal customer base. This financial year, the profits of the company increased manifold as the company introduced a new range of baked snacks that became very popular. As the year came to an end, the company had to decide how much dividend to pay to its shareholders. In view of the above and with the understanding that investors, in general, view an increase in dividend as good news and stock prices react positively to it, the Board of Directors were keen on declaring a high dividend. However, the Chief Finance Officer of the company pointed out that they need to keep many considerations in mind before declaring dividend. He drew the attention of the Board of Directors to the loan that the company has taken, containing a clause that imposes restriction on the payment of dividend. Further, he pointed out that even though the profits were high, a large amount of money was tied to the amounts receivables from the debtors. Without enough cash in hand, announcing a high dividend may not be practical. He also reminded the Board of Directors that ‘Quality Foods Ltd.’ was planning to expand into the breakfast cereal market. Since this new project will require a huge investment, the company will need to retain more money out of their earnings to finance it.
(a) Identify and explain any two factors affecting dividend decision that would have influenced the decision of the Board of Directors to pay a high dividend.
(b) Identify and explain any two factors to which the Chief Finance Officer drew the attention of the Board of Directors.
A position when a company is unable to meet its fixed financial charges like interest payment, dividend on preference shares and repayment obligations is referred to as ______ .
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