Consider two very different firms, M and N. Firm M is a mature firm in a mature

Question

Consider two very different firms, M and N. Firm M is a mature firm in a mature industry. Its annual net income and net cash flows are both consistently high and stable. However, M's growth prospects are quite limited, so its capital budget is small relative to its net income. Firm N is a relatively new firm in a new and growing industry. Its markets and products have not stabilized, so its annual operating income fluctuates considerably. However, N has substantial growth opportunities, and its capital budget is expected to be large relative to its net income for the foreseeable future.

            Q. What would be firm M

Explanation / Answer

Firm M: There is a cost to Retained earning . Since there is no growth opportunity , it is not prudent to increase the retained earning by not paying the dividend. So the dividend policy should be to distribute the income as much as possible.

Firm N : Here the income is fluctuating but there is growth opportunities. Here, to take advantage of the growth prospect we should not pay dividend and should invest the income in new opportunities. The shareholders will be duly compensated in terms of capital gains that happens when the share price increases.

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