Cash Flow Approach to Analyzing Dividend Policy

Given what firms are returning to their stockholders in the form of dividends or stock buybacks, how do we decide whether they are returning too much or too little? In the cash flow approach, we follow four steps. We first measure how much cash is available to be paid out to stockholders after meeting reinvestment needs and compare this amount to the amount actually returned to stockholders. We then have to consider how good existing and new investments in the firm are. Thirdly, based upon the cash payout and project quality, we consider whether firms should be accumulating more cash or less. Finally, we look at the relationship between dividend policy and debt policy.

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