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Dividend Policy Short Notes Part2

The document discusses various dividend payout policies, including stable, constant, and residual dividend policies. It outlines how stable policies maintain regular dividends regardless of earnings, while constant policies pay a fixed percentage of net income, and residual policies distribute leftover funds after financing profitable projects. Additionally, it highlights determinants and constraints affecting dividend decisions, such as availability of funds, cost of capital, legal constraints, and investment opportunities.

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Ruhaan Narang
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33 views3 pages

Dividend Policy Short Notes Part2

The document discusses various dividend payout policies, including stable, constant, and residual dividend policies. It outlines how stable policies maintain regular dividends regardless of earnings, while constant policies pay a fixed percentage of net income, and residual policies distribute leftover funds after financing profitable projects. Additionally, it highlights determinants and constraints affecting dividend decisions, such as availability of funds, cost of capital, legal constraints, and investment opportunities.

Uploaded by

Ruhaan Narang
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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Dividend Payout policies: Payout policies can be maintained by fixing the amount or rate of

dividend irrespective of the earnings of the company. The policies may include
Stable Dividend Policy
Constant Dividend Policy
Residual Dividend Policy
We discuss three types of dividend policies: stable dividend, constant dividend payout ratio, and
residual dividend policies. A stable dividend policy is one in which regular dividends are paid that
generally do not reflect short-term volatility in earnings. This type of dividend policy is the most
common because managers are very reluctant to cut dividends, as discussed earlier. A constant
dividend payout ratio policy is the policy of paying out a constant percentage of net income in
dividends. A residual dividend policy is based on paying out as dividends any internally generated
funds remaining after such funds are used to finance positive NPV projects. This type of policy often
has been mentioned in theoretical discussions of dividend policy but is rarely used in practice.
Constant Dividend Policy: Shareholders are given fixed amount of dividend irrespective of actual
earnings. Co. follows a practice of paying a certain fixed amt per share as dividend. For instance of a
share of INR 100, a Co. pays INR 15 as dividend. This amt would be paid YoY. The amount of
dividend may increase or decrease later on depending upon the financial health of the company but it
is generally maintained for a considerable period of time.

Co pays a Steady dividend with a consistency for a no of years. Co increases steady dividends if
earnings have increased to a higher permanent level & vice versa.
Stable Dividend Policy: The ratio of dividend to earnings is known as Payout ratio. Some companies
follow a policy of constant Payout ratio i.e. paying fixed percentage on net earnings every year. Under
the stable dividend policy, the percentage of profits paid out as dividends is fixed. For example, if a
company sets the payout rate at 6%, it is the percentage of profits that will be paid out regardless of
the amount of profits earned for the financial year.To quote from Page 74 of the annual report 2011 of
Infosys Technologies Limited.
“The Dividend Policy is to distribute up to 30% of the Consolidated Profit after Tax (PAT) of the
Infosys Group as Dividend.”
Residual dividend policy-Policy suggests that dividend should be viewed as a residual i.e amount
left over after meeting the financing req of all acceptable/profitable projects.
The residual theory suggests that dividends paid by a corporate should be viewed as a
residual, that is, the amt left over after meeting the financing requirement of all
acceptable/profitable investment projects. Div can be paid only out of the left over amt after
financing all new projects with positive NPV. If no amt is left there will be no div payments.
The treatment of div payment as a passive residual implies that div decisions are irrelevant.
The approach is guided by the availability of acceptable invst opportunities but is also
concerned with maintaining a desirable/target capital structure in deciding about cash
dividends .
Four steps are involved
1) Prepare capital budget to disclose capital exp of profitable investment opportunities
2) Decide on equity requirements, based on desired D/E ratio to support capex in Step 1
3) Use RE to the max to meet fund req decided in Step 2
4) Pay cash div only if available earnings>Eq funds needed in terms of the desired D/E
ratio

DETERMINANTS OF DIVIDEND POLICY


The dividend policy is affected by the following factors:
1. Availability of funds: If the business is in requirement of funds, then retained earnings could be a
good source. The reason being the saving of floatation cost and prevention of dilution of control
which happens in case of new issue of equity shares to public.
2. Cost of capital: If the financing requirements are to be executed through debt (relatively cheaper
source of finance), then it would be preferable to distribute more dividend. On the other hand, if the
financing is to be done through fresh issue of equity shares, then it is better to use retained earnings as
much as possible.
3. Capital structure: An optimum Debt Equity ratio should also be considered for the dividend
decision.
4. Stock price: Stock price here means market price of the shares. Generally, higher dividends
increase market value of shares and low dividends decrease the value.
5. Investment opportunities in hand: The dividend decision is also affected if there are investment
opportunities in hand. In that situation, the company may prefer to retain more earnings.
6. Trend of industry: The investors depend on some industries for their regular dividend income.
Therefore, in such cases, the firms have to pay dividend in order to survive in the market.
7. Expectation of shareholders: The shareholders can be categorised into two categories: (i) those who
invests for regular income, & (ii) those who invests for growth. Generally, the investor prefers current
dividend over the future growth.
8. Legal constraints: Section 123 of the Companies Act, 2013 which provides for declaration of
dividend sates that Dividend shall be declared or paid by a company for any financial year only:
(a) out of the profits of the company for that year arrived at after providing for depreciation in
accordance with the relevant provisions , or
(b) out of the profits of the company for any previous financial year or years arrived at after providing
for depreciation in accordance with the relevant provisions and remaining undistributed, or
(c) out of both, or
(d) out of money provided by the Central Government or a State Government for the payment of
dividend by the company in pursuance of a guarantee given by that Government.
It may be noted that, while computing the profits for payment of dividends any amount representing
unrealised gains, notional gains or revaluation of assets and any change in carrying amount of an asset
or of a liability on measurement of the asset or the liability at fair value shall be excluded.
9. Taxation: Before 1st April 2020, as per Section 115-O of Income Tax Act, 1961, dividend was
subject to dividend distribution tax (DDT) in the hands of the company. Dividend on which DDT was
paid, was to be exempted in the hands of the shareholder u/s 10(34). However, as per amendment
made by the Finance Act 2020, the exemption u/s 10(34) shall not apply to dividend received on or
after 1st April 2020 and the dividend income from shares held as investment shall be taxable under the
head of ‘Other income’ at the applicable slab rate. In nutshell dividend would be taxable in the hands
of investor.

Constraints on Paying Dividends

(i) Legal: Please see point no. (8) under the heading, “Determinants of Dividend Decisions”.
(ii) Liquidity: Payment of dividends means outflow of cash. Ability to pay dividends depends on cash
and liquidity position of the firm. A mature company does not have much investment opportunities,
nor its funds tied up in permanent working capital and, therefore has a sound cash position. A growth
oriented company in spite of having good profits need funds to expand its operations and permanent
working capital and therefore it is less likely to declare dividends.
(iii) Access to the Capital Market: By paying large dividends, cash position is affected. So, if new
shares have to be issued to raise funds for financing investment programmes and if the existing
shareholders cannot buy additional shares, then their control is diluted. In such a situation, payment of
dividends may be withheld and earnings are utilised for financing firm’s investment opportunities.
(iv)Investment Opportunities: If investment opportunities are inadequate, it is better to pay dividends
and raise external funds whenever necessary for such opportunities.
(c) Payout policies: Payout policies can be maintained by fixing the amount or rate of dividend
irrespective of the earnings of the company.

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