Unit -3 : Unit -3 Dividend Decision Meaning : Meaning The term ‘dividend’ refer to that part of divisible profits among its shareholders. In other words, dividend is that portion of company’s profit which is distributed among its shareholders as a percentage of par value of share or at a fixed rate per share according to the decision of its board of directors. Different types of dividend : Different types of dividend Cash Dividend
Special Dividend Dividend Policy : Dividend Policy Dividend policy is a very significant financial decision . It determines the divisions of earnings between payments to shareholders and retained earnings. If the value of firm is a function of its dividend-pay-out ratio , the dividend policy will affect directly the firms cost of capital. Meaning : Meaning ‘Dividend policy’ is a flexible and wide meaning word. This word is constituted with two words, dividend and policy. Dividend is that portion of profits of company which is distributed among its shareholders whereas policy means plan of action. Thus , the term dividend policy refers to the policy concerning quantum of profits to be distributed as dividend. Factors influencing dividend policy : Factors influencing dividend policy Past dividend rate
Age of company
Liquidity of funds
Stability in earning
Expectations of shareholders
Legal restrictions Types of Dividend Policy : Types of Dividend Policy Conservative Vs liberal Dividend Policy
Regular Vs Irregular
Stable dividend policy Theories : Theories 1.Relevance concept
2.Irrelevance concept IRRELEVANT CONCEPT : IRRELEVANT CONCEPT According to this theory, Dividend decision is irrelevant so far the valuation of the firm is concerned. The major argument indicating that dividends are irrelevant to the value of shares and the firms was first propounded by Modigliani and Meston Miller in 1961. according to Modigliani And Miller ,dividend policy of a firm is irrelevant as it no affect the wealth of the shareholders. They argued that the value of the firm depends on its earning potentiality and investment policy and not on the pattern of income distribution. Assumptions : Assumptions The capital market are perfect . Perfect market imply that (a) information is freely available to all, (b) Transactions and floatation costs do not exist .
There are either no taxes or there are no differences in the rates applicable to dividends and capital gains.
The firm has fixed investment policy.
Risk or uncertainty does not exist i.e ., investors are able to forecast future prices and dividend. Walter’s Approach : Walter’s Approach Professor James E. Walter has been a strong proponent of relevance dividend concept. He argues that the choice of dividend policies almost always affect the value of firm. The formula given by Walter shows how dividend can be used to maximize the wealth position of shareholders. He argues that in the long run , share prices reflect only the present value of expected dividends. Retentions influence stock prices only through their effect on future dividends. Assumptions : Assumptions Market value of shares in affected by the present values of future anticipated dividends.
Retained earning affect future
The firm has a very long or infinite life.
All earning are either distributed as dividends or invested internally immediately. Gordon’s Approach : Gordon’s Approach Myron Gordon has also been a proponent of relevance concept of dividends. He has developed a model explicitly for the valuation of equity shares based on the relationship of dividend policy and market value of the firm. Assumptions : Assumptions The firm is an all equity firm.
The corporate tax do not exist.
The internal rate of return is constant.