Inflation in a financial environment means that the fall in the value of money of a period of time (Lumby, 2007). The rate of inflation can vary from time to time and from one country to another. The inflation presence means that the monetary interest rate which is the rate that is usually quoted. Although, inflation is not the cause of the time value of money, but it value would not be affected through the fisher effect relationship (Lumby, 2007). Inflation expected or unexpected presence is likely to cause some problems for investment appraisal. High rate of inflation can cause investment appraisal problems as follows
1. A project estimation expected cash flow will be more difficult due to high inflation presence.
2. Market interest rate can be expected to rise when there is inflation within the economy of any nation.
Dayananda et.al (2002) says inflation will have a major effect on the expected project cash flow. The cash inflows and outflows of the project could be adequately affected by th high inflation rate. Interest rates and equity returns that are examples of market rates will also rise when the expected rate of inflation is high. However, as there is an increase in the market rates, the required return rate by investors will also increase. But if all cash flows and the discount rate are also affected by the expected inflation then the net present value of the project will remain the same whether or not the inflation is included or excluded. Although, some cash flows are not affected by the high inflation rates while other cash flows are affected where inflation degree will be varied. The higher the inflation rate, the higher the minimum return rate required by investors, in order for the loss of income rate due to a reduction in the value of money.
A company`s dividend policy is referred to the choice of companies if to pay out cash, in what fashion or in what amount should they pay their shareholders, (Brigham et.al, 2011). The important part of this policy is the decision of the company whether to pay a cash dividend, the amount this cash dividend should be as well as how regular the cash dividend should be allocated. In actual fact, dividend policy entails the decisions making by the company such as if to distribute cash to its investors through repurchase of share or through dividend specially designed instead of regular dividends or if the company will like to reply on stock instead of distribution of cash.
2.1. Dividends as Bad school
(Brigham et.al, 2011) argued that companies that are not profitable or earn very minute profits don`t pay out dividends. Based on the school of thought on the dividends, paying out dividend reduces the returns to shareholders after company`s taxes. However, the assumption of the shareholders would be to reduce the stock prices of the companies that make the payments, relatively to the companies that are not paying dividends. As a result, companies would be in better shape if the money they would have paid out as dividends are retained or if the repurchase the stock.
2.2. Dividends as good school
Dividend is a part of the profit made by a company (Brigham et.al, 2011). The directors of that firm will then look at the health of the company`s financial situation and then decide on if it is better to pay part of the company`s profit to the shareholders or to use the money for something else.
Dividends are paid out or increase by some companies for the wrong reasons (Baker and Powell, 2005). Firstly, they believe that investors prefer dividends to capital gains because dividends are certain but there is uncertainty in capital gains. On the other hand, some firms are tempted to pay dividends in the year that excess cash is generated by their operations, although is absolutely justifiable to give the shareholders excess cash but companies should take their long term investment needs and desires into consideration.