31. Pecking Order Theory. Alpha Corp. and Beta Corp. both produce turbo
encabulators. Both companies’ assets and operations are growing at the same rate, and
their annual capital expenditures are about the same. However, Alpha Corp. is the more
efficient producer and is consistently more profitable. According to the pecking order
theory, which company should have the higher debt ratio? Explain.
Alpha Corp is more profitable and is therefore able to rely to a greater extent on
internal finance (retained earnings) as a source of capital. It will therefore have less
dependence on debt, and the lower debt ratio.
19. Dividend Policy. Here are several assertions about typical corporate dividend
policies. Which of them are true? Write out a corrected version of any false statements.
a. Most companies set a target dividend payout ratio.
True.
b. They set each year’s dividend equal to the target payout ratio times that year’s
earnings.
False. Firms smooth out dividends and do not maintain a strict proportional
relationship between current earnings and dividends. They move dividends only part
of the way toward the target payout ratio when earnings change.
c. Managers and investors seem more concerned with dividend changes than dividend
levels.
True
d. Managers often increase dividends temporarily when earnings are unexpectedly high
for a year or two
False. Firms seem reluctant to reduce dividends and therefore do not increase
dividends in response to earnings increases that are not expected to persist, or that
are not expected to be representative of long-run earnings prospects.