Introduction to Corporate Finance

Ross et al.: Fundamentals

of Corporate Finance, Sixth

Edition, Alternate Edition

VI. Cost of Capital and

Long−Term Financial

Policy

18. Dividends and Dividend
    Policy

© The McGraw−Hill^649

Companies, 2002

compromise approach, the debt-equity ratio is viewed as a long-range goal. It is allowed

to vary in the short run if necessary to avoid a dividend cut or the need to sell new

equity.

In addition to having a strong reluctance to cut dividends, financial managers tend to

think of dividend payments in terms of a proportion of income, and they also tend to

think investors are entitled to a “fair” share of corporate income. This share is the long-

622 PART SIX Cost of Capital and Long-Term Financial Policy

FIGURE 18.4

Earnings ($)

1,000

667

333

0

–333 Time(quarters)

Year 1 Year 2 Year 3

Earnings

12341 2341234

Earnings for Big Department Stores, Inc.

FIGURE 18.5

Dollars

Time

(quarters)

Year 1 Year 2 Year 3

EPS

Cyclical

dividends

Stable-dollar

dividends

Cyclical dividend policy: Dividends are a constant proportion of earnings at each pay date.

Stable dividend policy: Dividends are a constant proportion of earnings over an earnings cycle.

123412341234

Alternative Dividend Policies for Big Department Stores, Inc.