A . Explain what the dividend payout ratio is and which firms typically have a high ratio and which firms may have the lowest. b. Many firms operate at a dividend payout ratio of less than 50%. Why do many firms not pay a larger percentage of income as dividends?
a . The dividend payout ratio is calculated as the annual dividend amount divided by the annual net income. Typically, utilities pay a high proportion of their earnings as dividends. In contrast, fast-growing companies in technology often pay nothing to stockholders.
b. Many firms do not pay out all of their income as dividends because there are other alternative uses of the income. Management's objective should be to maximize the wealth of the stockholders. Sometimes that can be achieved by paying dividends; other times it can be achieved by retaining the income and reinvesting it in alternatives such as purchasing replacement fixed assets or equipment which could be vital to the continuing operations of the company.
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