Dividend Decision

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By: mohan.chandra (119 month(s) ago)

this is useful to my ppt presentation

By: mohan.chandra (119 month(s) ago)

this is useful to my ppt presentation

By: mohan.chandra (119 month(s) ago)

this is useful to my ppt presentation

By: mohan.chandra (119 month(s) ago)

this is useful to my ppt presentation

By: mohan.chandra (119 month(s) ago)

this is useful to my ppt presentation

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Dividend Decision & Valuation of Firm:

Dividend Decision & Valuation of Firm Dept. of Business and Financial Studies University of Kashmir

Dividend Decision & Valuation of Firm:

Dividend Decision & Valuation of Firm Learning Goals: D ividend decision: what it is all about? D ividend decision & valuation of firm: Walters model Gordon’s model Linters model Graham & Dods model M-M Hypothesis

Dividend Decision & Valuation of Firm:

Dividend Decision & Valuation of Firm Dividend Decision Amt. distributed among shareholders Amount of earnings to be retained Impact on Internal source of finance Increases current wealth Information value

Dividend Decision & Valuation of Firm:

Dividend Decision & Valuation of Firm High payout: Less retained earnings…..slower growth perhaps lower MP Low payout: More RE…. Higher growth….higher capital gain….perhaps higher MP. Payout Ratio Low High

Dividend Decision & Valuation of Firm:

Dividend Decision & Valuation of Firm Q: Does div. decision influence Value of a shares D ividend Models: Walter’s Model Gordon’s Model Relevant Linter’s Model Graham & Dodd’s Model M-M Hypothesis……… Irrelevant

Walters Model:

Walters Model C ontention: C 1: Div. Decision influences Value of a share……..Optimum P/O Ratio E 1: Relationship between IRR & K Used in determining optimum Decision E 2: Classifies companies into: Growing, Normal, & Declining

Walters Model:

Walters Model Less fin. Resources Req. more funds Difficult to obtain funds Suff. Investment opportunities r > k Sufficient resource Req. less funds Access to funds Less feasible Investments opp. R=k Little res.Req Little access Revamping R<k Growth Matured Declining

Walters Model:

Walters Model A ssumptions: A 1: Only retained earnings used to Finance investments. A 2: IRR & K remains constant A 3: All earnings are either distributed or reinvested internally immediately A 4: EPS & Dividends never change A 5: Firm has infinite life

Walters Model:

Walters Model G rowth Firm………..r > k C: Optimum payout ratio is zero E: Able to reinvest at a rate… higher than k R esult At zero payout ratio, weighted benefit of RE will be more than the dividends

Walters Model:

Walters Model N ormal Firm………..r = k C: No optimum payout ratio E: Able to invest at a rate……=k R esult: At any payout ratio, weighted benefit of RE is equal to that of dividends .

Walters Model:

Walters Model D eclining Firm………r < k C: Optimum payout ratio is 100% E: No investment opp. or can earn Less than the rate expected by...

Walters Model:

Walters Model D + (r/k) ( E – D ) P = -------------------------- k Where: P = Market price of share D = Dividend per share r = IRR k = cost of capital E = EPS P = P resent value of stream of dividends & Capital gain Valuation of Shares

Walters Model:

Walters Model E xample: The following estimates about three companies viz., A, B, & C are given: A B C R …………15% 10% 8% K………….10% 10% 10% EPS………Rs 10 Rs 10 Rs 10

Walters Model:

Walters Model Payout Ratio = zero Div = 0 0+(.15/.10) (10-0) .10 = Rs 150 Div = 0 0+(.10/.10)(10-0) .10 = Rs 100 Div = 0 0+(.08/.10) (10-0) .10 = Rs 80 Payout ratio = 40% Div = 4 4+(.15/.10) (10- 4) .10 = Rs 130 Div = 4 4+(.10/.10)(10- 4) .10 = Rs 100 Div = 4 4+(.08/.10) (10- 4) .10 = Rs Payout ratio = 100% Div =10 10+(.15/.10)(10-10) .10 = Rs 100 Div =10 0+(.10/.10)(10-10) .10 = Rs 100 Div =10 0+(.08/.10)(10-10) .10 = Rs 100 Payout Ratio = zero Div = 0 0+(.15/.10) (10-0) .10 = Rs 150 Div = 0 0+(.10/.10)(10-0) .10 = Rs 100 Payout Ratio = zero Div = 0 0+(.15/.10) (10-0) .10 = Rs 150 Div = 0 0+(.08/.10) (10-0) .10 = Rs 80 Div = 0 0+(.10/.10)(10-0) .10 = Rs 100 Payout Ratio = zero Div = 0 0+(.15/.10) (10-0) .10 = Rs 150 Div = 4 4+(.08/.10) (10- 4) .10 = Rs Div = 0 0+(.08/.10) (10-0) .10 = Rs 80 Div = 0 0+(.10/.10)(10-0) .10 = Rs 100 Payout Ratio = zero Div = 0 0+(.15/.10) (10-0) .10 = Rs 150 Payout ratio = 40% Div = 4 4+(.08/.10) (10- 4) .10 = Rs Div = 0 0+(.08/.10) (10-0) .10 = Rs 80 Div = 0 0+(.10/.10)(10-0) .10 = Rs 100 Payout Ratio = zero Div = 0 0+(.15/.10) (10-0) .10 = Rs 150 Div = 4 4+(.10/.10)(10- 4) .10 = Rs 100 Payout ratio = 40% Div = 4 4+(.08/.10) (10- 4) .10 = Rs Div = 0 0+(.08/.10) (10-0) .10 = Rs 80 Div = 0 0+(.10/.10)(10-0) .10 = Rs 100 Payout Ratio = zero Div = 0 0+(.15/.10) (10-0) .10 = Rs 150 Div = 4 4+(.15/.10) (10- 4) .10 = Rs 130 Div = 4 4+(.10/.10)(10- 4) .10 = Rs 100 Payout ratio = 40% Div = 4 4+(.08/.10) (10- 4) .10 = Rs Div = 0 0+(.08/.10) (10-0) .10 = Rs 80 Div = 0 0+(.10/.10)(10-0) .10 = Rs 100 Payout Ratio = zero Div = 0 0+(.15/.10) (10-0) .10 = Rs 150 Payout ratio = 100% Div = 4 4+(.15/.10) (10- 4) .10 = Rs 130 Div = 4 4+(.10/.10)(10- 4) .10 = Rs 100 Payout ratio = 40% Div = 4 4+(.08/.10) (10- 4) .10 = Rs Div = 0 0+(.08/.10) (10-0) .10 = Rs 80 Div = 0 0+(.10/.10)(10-0) .10 = Rs 100 Payout Ratio = zero Div = 0 0+(.15/.10) (10-0) .10 = Rs 150 Div =10 10+(.15/.10)(10-10) .10 = Rs 100 Payout ratio = 100% Div = 4 4+(.15/.10) (10- 4) .10 = Rs 130 Div = 4 4+(.10/.10)(10- 4) .10 = Rs 100 Payout ratio = 40% Div = 4 4+(.08/.10) (10- 4) .10 = Rs Div = 0 0+(.08/.10) (10-0) .10 = Rs 80 Div = 0 0+(.10/.10)(10-0) .10 = Rs 100 Payout Ratio = zero Div = 0 0+(.15/.10) (10-0) .10 = Rs 150 Div =10 0+(.10/.10)(10-10) .10 = Rs 100 Div =10 10+(.15/.10)(10-10) .10 = Rs 100 Payout ratio = 100% Div = 4 4+(.15/.10) (10- 4) .10 = Rs 130 Div = 4 4+(.10/.10)(10- 4) .10 = Rs 100 Payout ratio = 40% Div = 4 4+(.08/.10) (10- 4) .10 = Rs Div = 0 0+(.08/.10) (10-0) .10 = Rs 80 Div = 0 0+(.10/.10)(10-0) .10 = Rs 100 Payout Ratio = zero Div = 0 0+(.15/.10) (10-0) .10 = Rs 150 Div =10 10+(.08/.10)(10-10) .10 = Rs 100 Div =10 10+(.10/.10)(10-10) .10 = Rs 100 Div =10 10+(.15/.10)(10-10) .10 = Rs 100 Payout ratio = 100% Div = 4 4+(.15/.10) (10- 4) .10 = Rs 130 Div = 4 4+(.10/.10)(10- 4) .10 = Rs 100 Payout ratio = 40% Div = 4 4+(.08/.10) (10- 4) .10 = Rs Div = 0 0+(.08/.10) (10-0) .10 = Rs 80 Div = 0 0+(.10/.10)(10-0) .10 = Rs 100 Payout Ratio = zero Div = 0 0+(.15/.10) (10-0) .10 = Rs 150

Gordon’s Model:

Gordon’s Model C ontention: C 1: Div. Decision Influences Value of Firm ………… Optimum P/O Ratio D etermination: D 1: Used IRR & K in determining optimum Pay out Ratio D 2: Classifies companies into Growth, Normal, & Declining.

Gordon’s Model:

Gordon’s Model P repositions of Gordon r > k Zero r < k 100% r = k….Irrelevant

Gordon’s Model:

Gordon’s Model Assumptions A 1: Firm is all equity A 2: Uses RE to finance investments. A 3: IRR & K remains constant A 4: Retention ratio once decided remains constant A 5: No corporate taxes A 6: Firm derives its earnings perpetually

Gordon’s Model:

Gordon’s Model C 2: If risk is considered then, P/ratio would influence Value even when r = k A ssumptions: A 1: Rational investors are risk averse A 2: Prefer nearer Div. than distant Div. A 3: Expect risk premium when retained

Gordon’s Model:

Gordon’s Model E ffects of Retention: E 1: Retention means postponement of current Div. in promise of more future div…………….. Risk E 2: More the risk, more the k….. based on Bird-In-The-Hand argument

Gordon’s Model:

Gordon’s Model B ird-in-the-Hand Argument One Bird in a hand is better than 2 birds in a bush Shareholders Prefer Nearer Div. Over Distant Dividends K rishman: Two identical stocks, one paying more dividend will have more MP.. vice versa

Gordon’s Model:

Gordon’s Model Relationship between p/ratio & k DR(k) RR(b ) Conclusion More the retention, more risk, more the k…less MP Less the retention, less risk, less the k… more MP K

Gordon’s Model: Valuation of shares:

Gordon’s Model: Valuation of shares D1 D2 Dn P = ------ +------ …..+----- (1+k) (1+k) (1+k ) W here: P = Market price of share D = Dividend per share r = IRR k = cost of capital E = EPS b = Retention ratio P = present value of stream of dividends E1 ( 1 – b ) = -------------------- k - br

Gordon’s Model: Valuation of shares:

Gordon’s Model: Valuation of shares 20 (1- 0.2) .11 – (0.2 x 0.08) = Rs 1,000 20 (1- 0.2) .11 – (0.2 x 0.11) = Rs 100 20 (1- 0.2) .11 – (0.2 x 0.12) = Rs 186 Payout Ratio = 80% 20 (1- 0.6) .11 – (0.6 x 0.12) = Rs 210 20 (1- 0.6) .11 – (0.6 x 0.11) = Rs 100 Payout Ratio = 40% 20 (1- 0.6) .11 – (0.6 x 0.08) = Rs 129 r = 8, k= .11 20 (1- 0.9) .11 – (0.9 x 0.08) = Rs 52.63 r =. 11, k=.11 20(1- 0.9) .11 – (0.9 x 0.1I) = Rs 181 Payout Ratio = 10% r =.12, k = .11 20 (1- 0.9) .11 – (0.9 x 0.12) = Rs 1,000

M-M Hypothesis :

M-M Hypothesis C ontention: P/ratio does not influence Value of a Firm Arguments: A1: Value…….. earning capacity & earnings …….investment decisions. A2: When company Retains, investor enjoys C/gain = amount of RE. When company pays investor enjoy Div. in value = amount of C/gain

M-M Hypothesis :

M-M Hypothesis A 3: Benefit of Div. is offset by external financing A 4: Shareholders are indifferent to Dividend Decision……..able to Construct Own Div. Policy

M-M Hypothesis :

M-M Hypothesis A ssumptions: A 1: Perfect capital market Easy to buy & sell No buyer/seller large enough to influence MP Access to information No transaction costs Securities are divisible A 2: Rational investors

M-M Hypothesis :

M-M Hypothesis A 3: No risk of uncertainty (dropped ) A 4: No corporate taxes …(no diff.) A 5: k & r is identical for all the shares A 6: IRR = k

M-M Hypothesis :

M-M Hypothesis C onclusion: C 1 : When r=k, then weighted benefit of RE will be equal to weighted benefit of Div…V constant C 2 : When r is same, no shift will take place from low yielding companies to high yielding companies.

M-M Hypothesis :

M-M Hypothesis V aluation of shares: P1 = Po ( 1 + k ) – D1 W here: P1 = market price per share at time 1 Po = market price per share at time 0 K = dr or cost of capital= r D1 = dividend per share at time 1

M-M Hypothesis :

M-M Hypothesis Example: ABC Comp. currently has outstanding 1,00,000 shares, selling at Rs 100 each. It is thinking to pay a div. of Rs 5 Ps at t1. K is 10%. What will be the price of the share if: A div. is not paid. A div. is paid @ Rs 5 per share. How many new shares are to be sold, if the company requires Rs 20 lakhs & the net profit is Rs 10 lakhs?

M-M Hypothesis:

M-M Hypothesis P 1 = Po ( 1 + k ) – D1 Po = Rs 100 K = 0.10 D1 = 0.0 P 1 = 100(1 + 0.10) –0……= 110 P 1 = 100(1 + 0.10) –5……= 105

M-M Hypothesis:

M-M Hypothesis No of shares: ∆np1 = I – ( E – D1 ) Where: ∆np1 = change in MP of share = 105 I = amount to be invested = 20 lacs E = earnings ……………... = 10 lacs D1 = Div. at t = 1………….. = 5 lacs ∆n105 = 20,00,000 – ( 10,00,000 -5,00,000) ∆n105 = 20,00,000 – 5,00,000 ∆n = 15,00,000 105 = 14,285

Traditional Approach:

Traditional Approach Advocated by Gram & Dodd A rguments: A1: Div. Dec. is a relevant………Influences value A2: Stock market places considerable Weight age on Div. than RE Weight assigned to DIV is 3 times the weight assigned to RE P = m( D + E/3 )

Traditional Approach:

Traditional Approach C riticism: Based on subjective judgment rather than on empirical evidence E xplanation E 1: Hypothesis Based on empirical evidence…..cite results of cross section regression analysis E 2: DIV. coefficient is much higher than RE .

Traditional Approach:

Traditional Approach Analysis: Conclusions reached by Gram & Dodd are not justified R 1: Omits risk……….., thus Distorts results R 2: Measurement of earnings Is subject to error… Transmitted to RE....... Coefficient is biased

Traditional Approach:

Traditional Approach

Traditional Approach:

Traditional Approach

Traditional Approach:

Traditional Approach

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