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    Dividend Policy PDF

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    MaherAh KhAn
    This document discusses dividend policy and various theories of dividend policy. It begins by defining dividends and explaining different types of dividends. It then defines dividend policy and discusses factors that affect dividend policy. Several dividend theories are presented, including: - Walter's model, which states that share price reflects expected future dividends and retention affects price through future dividends. - Gordon's model, which also views share price as reflecting future dividends and asserts dividend policy does impact share value. - Modigliani-Miller's irrelevant theory, which argues dividend policy does not impact share value if capital markets are perfect. - The traditional approach views dividends as part of the financing decision rather than an

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    Dividend Policy PDF

    Uploaded by

    MaherAh KhAn
    93 views45 pages
    This document discusses dividend policy and various theories of dividend policy. It begins by defining dividends and explaining different types of dividends. It then defines dividend policy and discusses factors that affect dividend policy. Several dividend theories are presented, including: - Walter's model, which states that share price reflects expected future dividends and retention affects price through future dividends. - Gordon's model, which also views share price as reflecting future dividends and asserts dividend policy does impact share value. - Modigliani-Miller's irrelevant theory, which argues dividend policy does not impact share value if capital markets are perfect. - The traditional approach views dividends as part of the financing decision rather than an

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    This document discusses dividend policy and various theories of dividend policy. It begins by defining dividends and explaining different types of dividends. It then defines dividend policy and discusses factors that affect dividend policy. Several dividend theories are presented, including: - Walter's model, which states that share price reflects expected future dividends and retention affects price through future dividends. - Gordon's model, which also views share price as reflecting future dividends and asserts dividend policy does impact share value. - Modigliani-Miller's irrelevant theory, which argues dividend policy does not impact share value if capital markets are perfect. - The traditional approach views dividends as part of the financing decision rather than an

    Copyright:

    © All Rights Reserved
    Download as PDF, TXT or read online from Scribd
    Download as pdf or txt
    93 views45 pages

    Dividend Policy PDF

    Uploaded by

    MaherAh KhAn
    This document discusses dividend policy and various theories of dividend policy. It begins by defining dividends and explaining different types of dividends. It then defines dividend policy and discusses factors that affect dividend policy. Several dividend theories are presented, including: - Walter's model, which states that share price reflects expected future dividends and retention affects price through future dividends. - Gordon's model, which also views share price as reflecting future dividends and asserts dividend policy does impact share value. - Modigliani-Miller's irrelevant theory, which argues dividend policy does not impact share value if capital markets are perfect. - The traditional approach views dividends as part of the financing decision rather than an

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    of 45

    DIVIDEND AND RETENTION POLICY

    Introduction :
     What is Dividend?
     What is dividend policy?
     Theories of Dividend Policy
     Relevant Theory
     Walter’sModel
     Gordon’s Model

     Irrelevant Theory
     M-M’s Approach
     Traditional Approach
    What is Dividend?

    “A dividend is a distribution to shareholders out of


    profit or reserve available for this purpose”.

    - Institute of Chartered Accountants of India


    Forms/Types of Dividend
     On the basis of Types of Share
     EquityDividend
     Preference Dividend

     On the basis of Mode of Payment


     Cash Dividend
     Stock Dividend

     Bond Dividend

     Property Dividend

     Composite Dividend
    Contd.

     On the basis of Time of Payment


     InterimDividend
     Regular Dividend

     Special Dividend
    What is Dividend Policy :

     “ Dividend policy determines the division of


    earnings between payments to shareholders and
    retained earnings”.

    - Weston and Bringham


    Contd.

    Dividend Policies involve the decisions, whether-

     To retain earnings for capital investment and other


    purposes; or
     To distribute earnings in the form of dividend among
    shareholders; or
     To retain some earning and to distribute remaining
    earnings to shareholders.
    Factors Affecting Dividend Policy
     Legal Restrictions
     Magnitude and trend of earnings
     Desire and type of Shareholders
     Nature of Industry
     Age of the company
     Future Financial Requirements
     Taxation Policy
     Stage of Business cycle
    Contd.

     Regularity
     Requirements of Institutional Investors
    Dimensions of Dividend Policy
     Pay-out Ratio
     Funds requirement
     Liquidity

     Access to external sources of financing

     Shareholder preference

     Difference in the cost of External Equity and Retained


    Earnings
     Control

     Taxes
    Contd.

     Stability
     Stable dividend payout Ratio
     Stable Dividends or Steadily changing Dividends
    Types of Dividend Policy

     Regular Dividend Policy


     Stable Dividend Policy
     Constant dividend per share
     Constant pay out ratio

     Stable rupee dividend + extra dividend

     Irregular Dividend Policy


    Dividend Theories

    Relevance Theories Irrelevance Theories


    (i.e. which consider dividend (i.e. which consider dividend
    decision to be relevant as it decision to be irrelevant as it does
    affects the value of the firm) not affects the value of the firm)

    Walter’s Gordon’s
    Model Model

    Modigliani and Traditional


    Miller’s Model Approach
    Walter’s Model
     Prof. James E Walter argued that in the long-run
    the share prices reflect only the present value of
    expected dividends. Retentions influence stock price
    only through their effect on future dividends. Walter
    has formulated this and used the dividend to
    optimize the wealth of the equity shareholders.
     Assumptions of Walter’s Model:
     Internal Financing
     constant Return in Cost of Capital

     100% payout or Retention

     Constant EPS and DPS

     Infinite time
    Formula of Walter’s Model
    D + r (E-D)
    P = k
    k
    Where,
    P = Current Market Price of equity share
    E = Earning per share
    D = Dividend per share
    (E-D) = Retained earning per share
    r = Rate of Return on firm’s investment or Internal Rate of Return
    k = Cost of Equity Capital
    Illustration :
     Growth Firm (r > k):
    r = 20% k = 15% E = Rs. 4
    If D = Rs. 4
    P = 4+(0) 0.20 /0 .15 = Rs. 26.67
    0.15
    If D = Rs. 2
    P = 2+(2) 0.20 / 0.15 = Rs. 31.11
    0.15
    Illustration :
     Normal Firm (r = k):
    r = 15% k = 15% E = Rs. 4
    If D = Rs. 4
    P = 4+(0) 0.15 / 0.15 = Rs. 26.67
    0.15
    If D = Rs. 2
    P = 2+(2) 0.15 / 0.15 = Rs. 26.67
    0.15
    Illustration :
     Declining Firm (r < k):
    r = 10% k = 15% E = Rs. 4
    If D = Rs. 4
    P = 4+(0) 0.10 / 0.15 = Rs. 26.67
    0.15
    If D = Rs. 2
    P = 2+(2) 0.10 / 0.15 = Rs. 22.22
    0.15
    Effect of Dividend Policy on Value of Share

    Case If Dividend Payout ratio If Dividend Payout Ration


    Increases decreases

    1. In case of Growing firm Market Value of Share Market Value of a share


    i.e. where r > k decreases increases

    2. In case of Declining firm Market Value of Share Market Value of share


    i.e. where r < k increases decreases

    3. In case of normal firm No change in value of No change in value of


    i.e. where r = k Share Share
    Criticisms of Walter’s Model

     No External Financing
     Firm’s internal rate of return does not always
    remain constant. In fact, r decreases as more and
    more investment in made.
     Firm’s cost of capital does not always remain
    constant. In fact, k changes directly with the firm’s
    risk.
    Gordon’s Model
     According to Prof. Gordon, Dividend Policy almost
    always affects the value of the firm. He Showed how
    dividend policy can be used to maximize the wealth
    of the shareholders.
     The main proposition of the model is that the value of
    a share reflects the value of the future dividends
    accruing to that share. Hence, the dividend payment
    and its growth are relevant in valuation of shares.
     The model holds that the share’s market price is equal
    to the sum of share’s discounted future dividend
    payment.
     Assumptions:
     Allequity firm
     No external Financing

     Constant Returns

     Constant Cost of Capital

     Perpetual Earnings

     No taxes

     Constant Retention

     Cost of Capital is greater then growth rate (k>br=g)


    Formula of Gordon’s Model

    E (1 – b)
    P =
    K - br

     Where,
    P = Price
    E = Earning per Share
    b = Retention Ratio
    k = Cost of Capital
    br = g = Growth Rate
    Illustration :
     Growth Firm (r > k):
    r = 20% k = 15% E = Rs. 4
    If b = 0.25
    P0 = (0.75) 4 = Rs. 30
    0.15- (0.25)(0.20)
    If b = 0.50
    P0 = (0.50) 4 = Rs. 40
    0.15- (0.5)(0.20)
    Illustration :
     Normal Firm (r = k):
    r = 15% k = 15% E = Rs. 4
    If b = 0.25
    P0 = (0.75) 4 = Rs. 26.67
    0.15- (0.25)(0.15)
    If b = 0.50
    P0 = (0.50) 4 = Rs. 26.67
    0.15- (0.5)(0.15)
    Illustration :
     Declining Firm (r < k):
    r = 10% k = 15% E = Rs. 4
    If b = 0.25
    P0 = (0.75) 4 = Rs. 24
    0.15- (0.25)(0.10)
    If b = 0.50
    P0 = (0.50) 4 = Rs. 20
    0.15- (0.5)(0.10)
    Criticisms of Gordon’s model
     As the assumptions of Walter’s Model and
    Gordon’s Model are same so the Gordon’s
    model suffers from the same limitations as
    the Walter’s Model.
    Modigliani & Miller’s Irrelevance Model

    Value of Firm (i.e. Wealth of Shareholders)

    Depends on

    Firm’s Earnings

    Depends on

    Firm’s Investment Policy and not on dividend policy


    Modigliani and Miller’s Approach
     Assumption
     Capital Markets are Perfect and people are Rational
     No taxes

     Floating Costs are nil

     Investment opportunities and future profits of firms


    are known with certainty (This assumption was
    dropped later)
     Investment and Dividend Decisions are independent
    M-M’s Argument
     If a company retains earnings instead of giving it
    out as dividends, the shareholder enjoy capital
    appreciation equal to the amount of earnings
    retained.
     If it distributes earnings by the way of dividends
    instead of retaining it, shareholder enjoys dividends
    equal in value to the amount by which his capital
    would have appreciated had the company chosen
    to retain its earning.
     Hence,
    the division of earnings between dividends and
    retained earnings is IRRELEVANT from the point of
    view of shareholders.
    Formula of M-M’s Approach

    1 ( D1+P1 )
    Po =
    (1 + p)

    Where,
    Po = Market price per share at time 0,
    D1 = Dividend per share at time 1,
    P1 = Market price of share at time 1
    1 (nD1+nP1)
    nPo =
    (1 + p)

     The expression of the outstanding equity shares of


    the firm at time 0 is obtained as:

    1 {nD1+(n + m)P1- mP1}


    nPo =
    (1 + p)
    mP1 = I – (X – nD1)
    Where,
    X = Total net profit of the firm for year 1

    nPo 1 [nD1+ (n + m)P1– {I – (X – nD1)}]


    =
    (1 + p)

    nPo 1 nD1+ (n + m)P1– I +X – nD1


    =
    (1 + p)
    nPo 1 (n + m)P1– I +X
    =
    (1 + p)
    Criticism of M-M Model

     No perfect Capital Market


     Existence of Transaction Cost
     Existence of Floatation Cost
     Lack of Relevant Information
     Differential rates of Taxes
     No fixed investment Policy
     Investor’s desire to obtain current income
    Traditional Approach
     This theory regards dividend decision merely as a
    part of financing decision because
     The earnings available may be retained in the business
    for re-investment
     Or if the funds are not required in the business they
    may be distributed as dividends.
     Thus the decision to pay the dividends or retain the
    earnings may be taken as a residual decision
     This theory assumes that the investors do not
    differentiate between dividends and retentions by
    the firm
     Thus, a firm should retain the earnings if it has
    profitable investment opportunities otherwise it
    should pay than as dividends.
    Synopsis
     Dividend is the part of profit paid to Shareholders.
     Firm decide, depending on the profit, the
    percentage of paying dividend.
     Walter and Gordon says that a Dividend Decision
    affects the valuation of the firm.
     While the Traditional Approach and MM’s
    Approach says that Value of the Firm is irrelevant to
    Dividend we pay.
    Bibliography

     Google
     Financial management by prasanna chandra.

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