Looking for the answer to the question below related to Financial Management?
Dividend Payout Ratio is
|A. PAT÷ Capital
B. DPS ÷ EPS
C. Pref. Dividend ÷ PAT
D. Pref. Dividend ÷ Equity Dividend
The Correct Answer Is:
- B. DPS ÷ EPS
The Dividend Payout Ratio is a crucial financial metric used by investors, analysts, and companies to assess the distribution of profits to shareholders in the form of dividends. It measures the percentage of earnings a company pays out to its shareholders as dividends, relative to the earnings it retains for reinvestment or other purposes.
The correct answer is B. DPS ÷ EPS, and we will explain why this is the accurate formula, along with detailed explanations for why the other options are not correct.
Correct Answer (B. DPS ÷ EPS):
B. DPS ÷ EPS stands for Dividends Per Share divided by Earnings Per Share. This formula calculates the proportion of a company’s earnings that are paid out to shareholders in the form of dividends for each share they own. It is widely accepted as the standard formula for calculating the Dividend Payout Ratio for several reasons:
- Reflects Shareholder Returns: The primary purpose of a dividend is to reward shareholders for their investment in the company. DPS represents the actual cash dividends distributed to each shareholder, and EPS represents the portion of earnings attributable to each share. Dividing DPS by EPS gives a clear picture of how much of the company’s earnings are being returned to shareholders.
- Simple and Understandable: This formula is straightforward and easy to understand, making it accessible to a wide range of stakeholders, including investors, analysts, and management. It directly relates dividends to earnings, which is the most relevant financial performance measure for shareholders.
- Alignment with Shareholder Interests: Shareholders are typically interested in both the company’s profitability (EPS) and the income they receive from their investments (DPS). Therefore, this formula aligns with shareholder interests, helping them assess the company’s dividend policy.
Now, let’s delve into why the other options are not correct:
A. PAT ÷ Capital (Profit After Tax divided by Capital):
This option does not accurately calculate the Dividend Payout Ratio. PAT (Profit After Tax) is the company’s net income after taxes, and Capital typically refers to the total invested capital in the company, which includes equity and debt. Dividing PAT by Capital doesn’t specifically measure the portion of earnings paid out as dividends to shareholders; it is a broader measure of profitability relative to the total invested capital.
C. Pref. Dividend ÷ PAT (Preference Dividend divided by Profit After Tax):
This formula calculates the ratio of preferred dividends to profit after tax. However, the Dividend Payout Ratio is generally concerned with common shareholders, not preferred shareholders. Preferred dividends are fixed and typically paid before common dividends, so including them in this ratio would not accurately represent the common shareholders’ dividend payout.
D. Pref. Dividend ÷ Equity Dividend (Preference Dividend divided by Equity Dividend):
This option is not a commonly used formula for the Dividend Payout Ratio. It divides preferred dividends by “Equity Dividend,” which is not a standard financial term. The formula’s lack of clarity and non-standard terminology make it an inappropriate choice for calculating the Dividend Payout Ratio.
In conclusion, the Dividend Payout Ratio is a critical financial metric that assesses the proportion of a company’s earnings distributed to common shareholders as dividends. The correct formula for calculating this ratio is B. DPS ÷ EPS, as it directly relates dividends per share to earnings per share, aligning with shareholder interests and providing a clear and easily understandable measure.
The other options, A. PAT ÷ Capital, C. Pref. Dividend ÷ PAT, and D. Pref. Dividend ÷ Equity Dividend, are not correct because they do not accurately capture the relationship between dividends and earnings or use non-standard terms, making them inappropriate for calculating the Dividend Payout Ratio.