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ASSIGNMENT - 2
DIVIDEND POLICY AND FACTORS
AFFECTING DIVIDEND POLICY





Submitted By : Submitted to :
Name: Himanshu Malhotra Dr. Anju Singla
Roll No.: 10105025 Applied Science Department
Branch: E&EC
Dated: 5
th
May, 2014





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What is Dividend Policy?
Dividend policy is the set of guidelines a company uses to decide how much of its
earnings it will pay out to shareholders. Whether to issue dividends and what amount,
is determined mainly on the basis of the company's unappropriated profit (excess cash)
and influenced by the company's long-term earning power. When cash surplus exists
and is not needed by the firm, then management is expected to pay out some or all of
those surplus earnings in the form of cash dividends or to repurchase the company's
stock through a share buyback program.
Some evidence suggests that investors are not concerned with a company's dividend
policy since they can sell a portion of their portfolio of equities if they want cash. This
evidence is called the "dividend irrelevance theory" and it essentially indicates that
an issuance of dividends should have little to no impact on stock price. That being said,
many companies do pay dividends.
Types of Dividend Policies
There are three types of dividend policies:
1) Residual Dividend Policy: Companies using the residual dividend policy choose
to rely on internally generated equity to finance any new projects. As a result,
dividend payments can come out of the residual or leftover equity only after all
project capital requirements are met. These companies usually attempt to
maintain balance in their debt/equity ratios before making any dividend
distributions, deciding on dividends only if there is enough money left over after
all operating and expansion expenses are met.
Typically, this method of dividend payment creates volatility in the dividend
payments that some investors find undesirable.
A primary advantage of the dividend-residual model is that with capital-projects
budgeting, the residual-dividend model is useful in setting longer-term dividend
policy. A significant disadvantage is that dividends may be unstable. Earnings
from year to year can vary depending on business situations. As such, it is
difficult to maintain stable earnings and thus a stable dividend. While the
residual-dividend model is useful for longer-term planning, many firms do not
use the model in calculating dividends each quarter
Example: Let's suppose that a company named ABC has recently earned $1,000
and has a strict policy to maintain a debt/equity ratio of 0.5 (one part debt to
every two parts of equity). Now, suppose this company has a project with a
capital requirement of $900. In order to maintain the debt/equity ratio of 0.5,
CBC would have to pay for one-third of this project by using debt ($300) and
two-thirds ($600) by using equity. In other words, the company would have to
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borrow $300 and use $600 of its equity to maintain the 0.5 ratio, leaving a
residual amount of $400 ($1,000 - $600) for dividends. On the other hand, if the
project had a capital requirement of $1,500, the debt requirement would be $500
and the equity requirement would be $1,000, leaving zero ($1,000 - $1,000) for
dividends. If any project required an equity portion that was greater than the
company's available levels, the company would issue new stock.

2) Dividend Stability Policy: The fluctuation of dividends created by the residual
policy significantly contrasts with the certainty of the dividend stability policy.
With the stability policy, quarterly dividends are set at a fraction of yearly
earnings. This policy reduces uncertainty for investors and provides them with
income.
Example: Suppose our imaginary company, ABC, earned $1,000 for the year
(with quarterly earnings of $300, $200, $100 and $400). If CBC decided on a
stable policy of 10% of yearly earnings ($1,000 x 10%), it would pay $25
($100/4) to shareholders every quarter. Alternatively, if CBC decided on a
cyclical policy, the dividend payments would adjust every quarter to be $30, $20,
$10 and $40, respectively. In either instance, companies following this policy are
always attempting to share earnings with shareholders rather than searching for
projects in which to invest excess cash.

3) Hybrid Dividend Policy: The final approach is a combination between the
residual and stable dividend policy. Using this approach, companies tend to view
the debt/equity ratio as a long-term rather than a short-term goal. In today's
markets, this approach is commonly used by companies that pay dividends. As
these companies will generally experience business cycle fluctuations, they will
generally have one set dividend, which is set as a relatively small portion of
yearly income and can be easily maintained. On top of this set dividend, these
companies will offer another extra dividend paid only when income exceeds
general levels.







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Factors Affecting Dividend Policy
Dividend Policy of a company is affected by many different factors. Before discussing
these factors let us discuss the real world factors that affect high and low dividend
payouts.
1) Real-World Factors Affecting Low Dividend Payouts: As we mentioned
earlier, some financial analysts feel that the consideration of a dividend policy is
irrelevant. They contend that investors have the ability to create "homemade"
dividends by adjusting their personal portfolios to reflect their own preferences.
For example, investors looking for a steady stream of income are more likely to
invest in bonds (in which interest payments don't change) than in a dividend-
paying stock (in which value can fluctuate). Because their interest payments
won't change, those who own bonds don't care about a particular company's
dividend policy. The second argument claims that little to no dividend payout is
more favourable for investors. Supporters of this policy point out that taxation
on a dividend are higher than on a capital gain. The argument against dividends
is based on the belief that a firm that reinvests funds (rather than paying them
out as dividends) will increase the value of the firm as a whole and consequently
increase the market value of the stock. When investors sell, they profit from a
lower-taxed capital gain. According to the proponents of the no-dividend policy,
investors benefit more in the long run from the company's undertaking more
projects, repurchasing its own shares, acquiring new companies and profitable
assets, and reinvesting in financial assets. A third argument in favor of low
dividends is the high cost to a firm of issuing new stock. In other words, to avoid
the need to raise money through the issuance of new stock, which is expensive,
firms should retain most or all of their earnings and pay little to no dividends to
investors

2) Real-World Factors Affecting High Dividend Payouts: In opposition to these
three arguments is the idea that a high dividend payout is important for
investors because dividends provide certainty about the company's financial
well-being; dividends are also attractive for investors looking to secure current
income.
In addition, there are many examples of how the decrease and increase of a
dividend distribution can affect the price of a security. Companies that have a
long-standing history of stable dividend payouts would be negatively affected by
lowering or omitting dividend distributions; on the other hand, these companies
would be positively affected by increasing dividend payouts or making additional
payouts of the same dividends. Furthermore, companies without a dividend
history are generally viewed favourably when they declare new dividends.

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Now, the major factors affecting dividend policy are:
1) Stability of Earnings- The nature of business has an important bearing on the
dividend policy. If a firm has relatively stable earnings, it is more likely to pay
relatively larger dividend than a firm with relatively fluctuating earnings.
2) Legal Requirements: There is no legal compulsion on the part of a company to
distribute dividend. However, there certain conditions imposed by law regarding
the way dividend is distributed. In order to protect the interests of creditors an
outsiders, the companies Act 1956 prescribes certain guidelines in respect of the
distribution and payment of dividend. Moreover, a company is required to
provide for depreciation on its fixed and tangible assets before declaring
dividend on shares. It proposes that Dividend should not be distributed out of
capita, in any case. Likewise, contractual obligation should also be fulfilled, for
example, payment of dividend on preference shares in priority over ordinary
dividend
3) Firms Liquidity Position: Availability of cash and sound financial position is
also an important factor in dividend decisions. In spite of sufficient retained
earnings, the firm may not be able to pay cash dividend if the earnings are not
held in cash
4) Extent of Share Distribution: Nature of ownership also affects the dividend
decisions. A closely held company is likely to get the assent of the shareholders
for the suspension of dividend or for following a conservative dividend policy. On
the other hand, a company having a good number of shareholders widely
distributed and forming low or medium income group, would face a great
difficulty in securing such assent because they will emphasise to distribute
higher dividend.
5) Taxation Policy: High taxation reduces the earnings of he companies and
consequently the rate of dividend is lowered down. Sometimes government
levies dividend-tax of distribution of dividend beyond a certain limit. It also
affects the capital formation. N India, dividends beyond 10 % of paid-up capital
are subject to dividend tax at 7.5 %
6) Policy of Control: Policy of control is another determining factor is so far as
dividends are concerned. If the directors want to have control on company, they
would not like to add new shareholders and therefore, declare a dividend at low
rate. Because by adding new shareholders they fear dilution of control and
diversion of policies and programmes of the existing management. So they prefer
to meet the needs through retained earnings. If the directors do not bother about
the control of affairs they will follow a liberal dividend policy. Thus control is an
influencing factor in framing the dividend policy.
7) Access to Capital Market: If a firm has easy access to capital markets in raising
additional financing, it does not require more retained earnings. So a firm's
dividend payment capacity becomes high.
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8) Desire of Control: When the needs for additional financing arise, the
management of the firm may not prefer to issue additional common stock
because of the fear of dilution in control on management. Therefore, a firm
prefers to retain more earnings to satisfy additional financing need which
reduces dividend payment capacity.
Case Study: Dabur India Ltd.
Declaration
Dividend shall be declared or paid only out of -
i) Current Years profit
a) After providing for depreciation in accordance with law
b) After transferring to the reserves such amount of Profit as may be prescribed,
or
ii) The Profits for any previous financial year(s)
a) after providing for depreciation in accordance with law, and
b) remaining undistributed, or
iii) out of i) & ii) both
Losses
Before declaring any dividend,
a) The losses, if any, of any previous year(s) must be set off
b) Against the profits of the Company for the current year or previous years.

Amount of Dividend
1. Board shall endeavour to maintain the Dividend Payout Ratio. (Dividend/ Net Profit
for the year) as near as possible to 50% subject to
a) Companys need for Capital for its growth plan
b) Positive Cash Flow
Factors To Be Considered Before Declaring Dividend
1. Plough back of profits i. e. future capital expenditure programme including
a) New project
b) Expansion of capacities of existing units
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c) Renovation/ Modernisation
d) Major Repairs & Maintenance
2. Likelihood of crystallization of contingent liabilities, if any
3. Contingency Fund
4. Acquisition of brands/ businesses
5. Sale of brands/ businesses.
Dividend Summary for Dabur India Ltd.
For the year ending March 2013, Dabur India has declared an equity dividend of
150.00% amounting to Rs 1.5 per share. At the current share price of Rs 180.35 this
results in a dividend yield of 0.83%.
The company has a good dividend track report and has consistently declared dividends
for the last 5 years.




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Case Study: Bharti Airtel Ltd.
1). The profits of the Company, subject to any special rights relating thereto created or
authorised to be created by these Articles and subject to the provisions of these Articles,
shall be divisible among the Members in proportion to the amount of capital paid up on
the share held by them respectively. Provided always that subject as aforesaid any
capital paid up on a share during the period in respect of which a dividend is declared
shall unless the Board otherwise determine, only entitle the holder of such share to a
proportionate amount of such dividend as from the date of payment.
2) No dividend shall be paid by the Company in respect of any share except to the
registered holder of such share or to his order or to his banker.
3) (i) The Board may, before recommending any dividend, set aside out of the profits of
the Company such sums as it thinks proper as a reserve or reserves which shall, at the
discretion of the Board, be applicable for any purpose to which the profits of the
Company may be properly applied including provisions for meeting contingencies or for
equalising dividends and pending such application, may at the like discretion, either be
employed in the business of the Company or be invested in such investments, other
than shares of the Company as the Board may, from time to time think fit.
(ii) The Board may also carry forward any profits which it may think prudent not to
divide, without setting them aside as a reserve.
4) Notice of any dividend that may have been declared shall be given to the persons
entitled to share therein in the manner mentioned in the Act and these Articles.
5) No dividend shall bear interest against the Company.
6) The Company may issue a duplicate cheque or dividend warrant or interest warrant
on shareholder or holder of debenture furnishing such indemnity or otherwise as the
Board may think proper.
7) The Company in General Meeting may declare a dividend to be paid to the Members
according to their respective rights and interests in the profits and may, subject to the
provisions of Section 207 of the Act, fix the time for payment.
8) No larger dividend shall be declared than is recommended by the Board, but the
Company in General Meeting may declare a smaller dividend.
9) The Board may from time to time declare and pay to the Members such interim
dividends as appear to the Board to be justified by the financial position of the
Company.
10) Subject to the provisions of the Act and these Articles, no dividend shall be payable
except in cash. Provided that nothing in this Article shall be deemed to prohibit the
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capitalisation of profits or reserves of the Company for the purposes of issuing fully paid
up Bonus Share or paying up any amount for the time being unpaid on any shares held
by the Members of the Company.
11) Dividend may be paid by cheques or warrant or by a payslip or receipt having the
force of a cheque or warrant sent through the post to the registered address of the
Member or person entitled or in case of joint holders to that one of them first named in
the Register in respect of the joint holding or in case of registered shareholder having
registered address outside India by telegraphic transfer to such bank as may be
designated from time to time by such Members. Every such cheque or warrant shall be
made payable to the order of the person to whom it is sent. The Company shall not be
liable or responsible for any cheque or warrant or payslip or receipt lost in
transmission, or for any dividend lost to the Member or person entitled thereto by the
forged endorsement of any cheque or warrant or the forged signature on any payslip or
receipt or the fraudulent recovery of the dividend by any other person by any means
whatsoever.
12) Any dividend due from the Company to a Member, without the consent of the such
Member, be applied by the Company in or towards payment of any money due from
time to time to the Company for calls.
13) Where the Company has declared a dividend but which has not been paid or
claimed within 30 days from the date of declaration to any shareholder entitled to the
payment of the dividend, the Company shall within 7 days from the date of expiry of the
said period of 30 days, open a special account in any scheduled bank called Unpaid
Dividend of Bharti Airtel and transfer to the said account, the total amount of dividend
which remains unpaid. Any money transferred to the unpaid dividend account of the
Company which remains unpaid or unclaimed for a period of seven years from the date
of such transfer, shall be transferred by the Company to the Investor Education and
protection Fund established by the Central Government. No unclaimed or unpaid
dividend shall be forfeited by the Board.
Dividend Summary for Bharti Airtel Ltd.
For the year ending March 2013, Bharti Airtel has declared an equity dividend of
20.00% amounting to Rs 1 per share. At the current share price of Rs 322.90 this results
in a dividend yield of 0.31%.
The company has a good dividend track report and has consistently declared dividends
for the last 5 years.
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