Chartered Financial Analyst (CFA) Practice Exam Level 2

In which phase of a company's life cycle is dividend payout increasing while earnings are high but declining?

1. Mature Phase

2. Transition Phase

3. Initial Growth Phase

4. Declining Phase

The correct answer is: Transition Phase

In the scenario described, the company is experiencing a situation where dividend payouts are increasing despite a decline in earnings, which indicates that it is in the Transition Phase of its life cycle. During the Transition Phase, a company often faces changes in its market position, product life cycles, or competitive dynamics, leading to fluctuating performance metrics. Although earnings are high in this phase, they can begin to decline as the company navigates these shifts. However, management may choose to increase dividend payouts to signal confidence to investors or to maintain shareholder loyalty, even if this strategy comes at the expense of reinvesting profits back into the business. This choice reflects a common strategic decision where the emphasis shifts towards providing returns to shareholders in the face of declining growth prospects. The other phases, such as the Mature Phase, Initial Growth Phase, and Declining Phase, represent different dynamics where the relationship between earnings and dividend policy would typically behave differently, emphasizing the unique characteristics of the Transition Phase.