Dividend Policies

Views:
 
Category: Education
     
 

Presentation Description

It may be helpful for MBA students

Comments

By: neerja (123 month(s) ago)

gud one, n helpful too

By: mehroz (127 month(s) ago)

very nice

Presentation Transcript

Financial ManagementSection A - Unit VDIVIDEND POLICIES : 

Financial ManagementSection A - Unit VDIVIDEND POLICIES By ANUP K SUCHAK

What is Dividend Policy : 

What is Dividend Policy 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.

Determinant or Factors affecting Dividend Policy : 

Determinant or Factors affecting Dividend Policy Availability of Divisible Profits Availability of Profitable Reinvestment Opportunities Availability of Liquidity Inflation Effect on Market Prices Composition of Shareholding Company’s own policy regarding stability of dividend Contractual restrictions by Financial Institutions Extent of access to external sources Attitude and Objectives of Management

Slide 4: 

Dividend Theories Relevance Theories (i.e. which consider dividend decision to be relevant as it affects the value of the firm) Irrelevance Theories (i.e. which consider dividend decision to be irrelevant as it does not affects the value of the firm) Walter’s Model Gordon’s Model Modigliani and Miller’s Model

GORDON’S MODEL OF DIVIDEND POLICY : 

GORDON’S MODEL OF DIVIDEND POLICY 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 of Gordon Growth Valuation Model. : 

Assumptions of Gordon Growth Valuation Model. The firm is an all equity firm and has no debt External financing is not used in the firm. Retained earnings represent the only source of financing. The internal rate of return is the firm’s cost of capital ’k’. It remains constant and is taken as the appropriate discount rate. Future annual growth rate dividend is expected to be constant. Growth rate of the firm is the product of retention ratio and its rate of return. Cost of Capital is always greater than the growth rate. The company has perpetual life and the stream of earnings are perpetual. Corporate taxes does not exist. The retention ratio ‘b’ once decided upon, remain constant. Therefore, the growth rate g=br, is also constant forever.

Walter’s Valuation Model : 

Walter’s Valuation 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.

Formula of Walter’s Model : 

Formula of Walter’s Model D + r (E-D) k P = 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

Assumptions of Walter’s Model : 

Assumptions of Walter’s Model All financing is done through retained earnings and external sources of funds like debt or new equity capital are not used. Retained earnings represents the only source of funds. With additional investment undertaken, the firm’s business risk does not change. It implies that firm’s IRR and its cost of capital are constant. The return on investment remains constant. The firm has an infinite life and is a going concern. All earnings are either distributed as dividends or invested internally immediately. There is no change in the key variables such as EPS or DPS.

Effect of Dividend Policy on Value of Share : 

Effect of Dividend Policy on Value of Share

Criticisms of Walter’s Model : 

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.

Illustration 1 (In case of Growing Firm) : 

Illustration 1 (In case of Growing Firm) The earnings per share of a company are Rs. 10. The Equity Capitalization rate is 10%. Internal Rate of return on retained earnings is 20%. Using Walter’s formula: What should be the optimum payout ratio of the company? What should be the price of share at optimum payout ratio? How shall this price be affected if different payout (say 80%) were employed?

Illustration 2 (In case of Normal Firm) : 

Illustration 2 (In case of Normal Firm) The earnings per share of a company are Rs. 10. The Equity Capitalization rate is 10%. Internal Rate of return on retained earnings is 10%. Using Walter’s formula: What should be the optimum payout ratio of the company? What should be the price of share at optimum payout ratio? How shall this price be affected if different payout (say 80%) were employed?

Illustration 3 (In case of Declining Firm) : 

Illustration 3 (In case of Declining Firm) The earnings per share of a company are Rs. 10. The Equity Capitalization rate is 20%. Internal Rate of return on retained earnings is 10%. Using Walter’s formula: What should be the optimum payout ratio of the company? What should be the price of share at optimum payout ratio? How shall this price be affected if different payout (say 80%) were employed?

Illustration 4 : 

Illustration 4 The earning per share of a company are Rs. 10 and the rate of capitalization applicable to it is 10%. The company has before it the option of adopting a payout of 20% or 40% or 80%. Using Walter’s formula, compute the market value of the company’s share if the productivity of retained earning is (a) 20% (b) 10% and (c) 8%. What inference can be drawn from the above exercise?

Modigliani & Miller’s Irrelevance Model : 

Modigliani & Miller’s Irrelevance Model According to M-M, under a perfect market situation, the dividend policy of a firm is irrelevant as it does not affect the value of the firm. They argue that the value of the firm depends on the firm’s earnings and firm’s earnings are influenced by its investment policy and not by the dividend policy

Modigliani & Miller’s Irrelevance Model : 

Modigliani & Miller’s Irrelevance Model Depends on Depends on

Assumption of M-M Model : 

Assumption of M-M Model Perfect Capital Market: This means that: The investors are free to buy and sell securities. The investors behave rationally. There are no transaction cost/ flotation cost. They are well informed about the risk-return on all types of securities. No investor is large enough to affect the market price of a share. No Taxes Fixed Investment Policy No Risk

Formulae of M-M Model : 

Formulae of M-M Model According to M-M model the market price of a share, after dividend declared, is calculated by applying the following formula: P1 + D1 1 + Ke Where, P0 = Prevailing market price of a share P1 = Market Price of a share at the end of the period one D1 = Dividend to be received at the end of period one Ke = Cost of equity capital P0 =

Formulae of M-M Model : 

Formulae of M-M Model The number of shares to be issued to implement the new projects is ascertained with the help of the following: I – (E-nD1) P1 Where, ΔN = Change in the number of shares outstanding during the period. I = Total Investment amount required for capital budget E = Earning of net income of the firm during the period n = Number of shares outstanding at the beginning of the period D1 = Dividend to be received at the end of period one P1 = Market price of a share at the end of period one ΔN =

Criticism of M-M Model : 

Criticism of M-M Model No perfect Capital Market Existence of Transaction Cost Existence of Floatation Cost Lack of Relevant Information Taxes Exist No fixed investment Policy Investor’s desire to obtain current income

authorStream Live Help