Dividend refers to the portion of net income paid out to Shareholders

It is paid to shareholders in cash or stock for making Investment and bearing risk.
→ The percentage of earnings paid out in the form of cash dividend is known as Dividend
payout Ratio (DPR)
A company may retain some portion of its earnings to finance new investment. The percentage of
earnings retained in the firm is called retention ratio
→ Dividend policy is concerned with determining the proportion of firm’s earnings into dividend
and retain earning in the firm.
A firm has three alternatives regarding the distribution of its earnings.
a. It can distribute all of its earnings for reinvestment of cash dividends or,
b. It can retain all of its earnings in the form of investment in new project.
c. It can distribute a part of earnings for as dividends and retain the rest for reinvestment purpose.

Types of dividends
Basically, there are two types of dividends:
Cash dividend
Stock dividend
Cash Dividend: Cash Dividend is the most popular form of dividend. A firm which has enough
cash and does not have expansion program in near future prefers Cash dividend. If a company
declares cash dividend before the Closure of the fiscal year, it is known as interim dividend and
if it declares after the Completion of fiscal year, it is known as final dividend

→ Stock dividend: Stock dividend, also known as bonus share is another popular form of
dividend. A firm with enough profit but weak liquidity position prefers to distribute bonus shares
of stock dividend.

Factors affecting dividend policy

Legal requirements
There is no legally mandatory to the company for dividend distribution. However, there are
certain conditions imposed by law regarding the distribution of dividend. Generally, there are
three rules relating to dividend payment. They are the net profit rule, the capital impairment rule
and insolvency rule.

Investment opportunities
If a firm has better investment opportunities with higher expected rate of return as compared to
cost of capital, the firm prefers to retain the earnings for reinvestment rather than distributing
cash dividends. Thus, the amount of dividend payment also depends on investment opportunities.

Stability of earning
A firm having relatively more stable earning can pay larger dividend than the firm having
fluctuating earnings. Because the firm with fluctuating earning has more uncertainty about its
future earnings. As a result, it prefers to retain more from current earnings.

Growth prospects
A rapidly growing firm usually requires huge funds to invest in bigger projects. Thus, the firm
instead of paying larger dividend attempts to retain larger portion of its earning and avoids the
expenses of public stock offering. Thus, the firm pays lower amount of dividend.

Access to capital market

If a firm has easy access to capital market it retains less and pays more dividend because it can
easily raise funds from the market whenever the funds is needed.

Need to repayment of debt

If the firm has to repay the debt in the current year, it requires more funds and thus retains more
profit and pays lower amount of dividend.

Liquidity position of the firm

The liquidity position of a firm also affects the dividend payment to be made To the
shareholders. Dividend payment represents cash outflows to the firm. Thus, if the liquidity of
firm is higher, it becomes able to pay high dividend.

Dividend payment procedures

A company needs to follow the certain procedures for declaration and payment of dividend.
Once the dividend decision taken by the board of directors, such procedures must be followed by
all the companies.

Declaration date
It is the date on which the board of directors pass resolution to pay dividend. In other words, it is
the announcement date of board of directors to pay dividend at certain rate to the shareholders.
Onward this date, dividend payment becomes the liability of the firm.

Holder of record date

It is the date until which a person who has purchased shares before ex- dividend date must
register his/her name in the company register. In other words, it is the final date of company. The
main logic of this date is that the seller’s name should be replaced by the buyer’s name in the
company’s register for the dividend purpose.

Ex-dividend date
It is the date on and after which the right to the current dividend no longer goes to the new
purchase of stock. This date normally will be the four days before the holder of record date. Ex-
dividend date may vary from country to -country and companies may also determine themselves.
In Nepalese capital market, company publishes the notice of book closer date.

Payment date
It is the date on which the company starts to pay dividend or mail cheques to all the stockholders
recorded on the holder of record date. In above example, January 5, 2018 is the payment date.

Dividend payout schemes

The systems followed by the companies for payment of dividend are known as dividend payout
schemes. Following are the major dividend payout schemes.

Residual dividend policy

Under this dividend policy a firm first finance to its profitable investment opportunities and only
if the earnings still remain, it will be distributed as dividend. According to this dividend policy,
dividend distribution depends upon the investment policy of the firm.
This policy is based on the assumption that the firm wishes to minimize the need of external
equity and firm wishes to maintain its current capital structure. Under this policy, the dividend
payment will vary from year to year depending on available investment opportunities and debt
equity ratio.

Regular or stable dividend policy

The term ‘Stability’ in dividend policy refers to the consistency or lack of variability in the
stream of dividend payment. In other words, it refers to the regular payment of cash dividend to
the stockholders.
The different types of dividend payment are

I. Regular dividend policy/stable or constant amount of dividend:-

Under this scheme, dividend paid in fixed amount in each year. A company pays constant or
equal rupee dividend per share each year. It is not considering the fluctuation in the earning. For
example, Rs 5 or 10 per share.

II. Constant payout ratio:-

Under this schemes, dividend is paid in a fixed percentage of earnings. Since, the rate of
dividends will fluctuate with earnings fluctuations. It ensures that dividends are paid when
profits are earned and avoided when it incurs losses. For example, 10%, 20% etc.

III. Low regular plus extra dividend policy:-

 This scheme compromises above both stable dividend and constant payout ratio. Under this
scheme, the company should pay first low dividend and after increasing earnings paid extra
dividends. The low regular dividend can usually be maintained even when earnings decline
and extra dividends can be paid when excess earnings are available.

Stock split:
A stock split is an increase in the number of authorized issued and outstanding shares of stock,
coupled with a proportionate reduction in the shares par value. A Stock split results In a
reduction in par or stated value Per share.
After Stock Split:
1. Number of shares Increases
2. Par value per share Decreases
3. Book value per share Decreases
4. Market value per share Decreases

Formula:

1. Number of shares after stock split = No. of shares before stock split X stock split ratio.

2. MVPS/BVPS) PV after stock split = MVPS/BVPS/PV before Stock split ÷ Stock split
Ratio

Reverse stock spilt:

An action taken by a firm to reduce the number of Shares outstanding by increasing the par value
of the stock is reverse stock split. Reverse stock split also increases earning per share and
dividend per share.
After Reverse Stock Split:
1. Number of shares decreases
2. Market value per share increases.
3 Book value per share increases
4. Par value per share Increases

Formula

1. Number of shares after Reverse stock split = Number of shares before Reverse stock split
× Reverse Stock split ratio

2. MVPS/BVPS/PV after Reverse stock split = MVPS/BVPS/PV before Reverse Stock split
÷ Reverse stock split Ratio

Stock Re-purchase:
Stock Repurchase is Buying back its own shares by the company from the markets Repurchased
stocks are also known as Treasury stock.
The price for repurchasing the stock that brings Capital gain equal to the cash dividend
otherwise to be paid is called equilibrium repurchase price.

P* = N × P o
/ N-n
Where.
P* = Equilibrium share repurchase price
N= Number of shares prior to distribution
n = Number of shares to be repurchased
Po = Current market price per share prior to distribution.

Advantages of stock repurchase

Following are the advantages of stock repurchase to the company:

a. It utilizes the idle cash of the firm when there are no profitable opportunities for
investment.

b. It increases earning per share, dividend per share and market price per share.

c. The purchasing shareholders will be benefited as the offered price of company is higher
than the current market price of the share.

Disadvantages of stock repurchase

Following are the disadvantages of repurchase of stock of company:

a. If a company does not have long term goal the remaining shareholders may lose.

b. It causes loss of investment earning.

c. It is disadvantageous to the remaining stockholders due to announcement of high price

for the repurchased stock.

d. It may have chance of unfair practice as the selling shareholders may not be well
informed.

e. It may have negative impact from investment perspective.