CHAPTER - 18

Dividend Policy

PRACTICAL CONSIDERATION IN PAYING DIVIDENDS  Financial Need of company.  Shareholders Expectations.  Closely / Widely Held Company.  Constraints on Paying Dividends.
    

Legal Restrictions Liquidity Borrowing Capacity Access to the Capital Markets Restrictions in Loan Agreements

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 3 .  Constant Dividend per Share Plus Extra Dividend.STABILITY OF DIVIDENDS Constant Dividend per Share or Dividend Rate.  Constant Payout.

 4 .  Investors’ desire for current income.SIGNIFICANCE OF STABILITY OF DIVIDENDS Resolutions of investors uncertainty.  Institutional Investors’ Requirement.  Raising Additional Finances.

5 . Limitations of Bonus Issue.FORMS OF DIVIDENDS Cash Dividends  Bonus Shares (Stock Dividend). Conditions for Issue of Bonus Shares.     Advantages for Shareholders and Company.

CORPORATE DIVIDEND BEHAVIOUR Lintners Model DIVt  a +b * p * EPSt  (1  b)DIVt  1  et .

7 CHAPTER .17 Dividend Theory .

Investment and Financing Decision.8 ISSUES IN DIVIDEND POLICY Earnings to be Distributed – High Vs.  Effects – Taxes.  Objective – Maximize Shareholders Return. Low Payout.  .

9 RELEVANCE VS. IRRELEVANCE Walter's Model  Gordon's Model  Modigliani and Miller Hypothesis  The Bird in the Hand Argument  Informational Content  Market Imperfections  .

10 WALTERS MODEL Assumptions  Valuation  Optimum Payout Ratio  Criticism  .

11 ASSUMPTIONS Internal Financing  Constant Return and Cost of Capital  100% Payout or Retention  Constant EPS and DIV  Infinite Time  .

VALUATION  Market price per share is the sum of the present value of the infinite stream of constant dividends and present value of the infinite stream of capital gains. P  (DIV / k )  (r / k ) (EPS – DIV) k 12 .

1)  (10  4)  Rs 130 0.1 13 .10.1 (0.15 / 0.1) P  (4 / 0.08 / 0.1) P  (4 / 0. 0.1 (0. 0.15.10 / 0.1)  (10  4)  Rs 100 0.EXAMPLE r  0.08 k  0.1)  (10  4)  Rs 88 0.1) P  (4 / 0.10 EPS  Rs 10 DPS  40% (0.

14 OPTIMUM PAYOUT RATIO Growth Firms – Retain all earnings  Normal Firms – Distribute all earnings  Declining Firms – No effect  .

15 CRITICISM No external Financing  Constant Rate of Return  Constant opportunity cost of capital  .

16 GORDON'S MODEL Assumptions  Valuation  Optimum Payout Ratio  Criticism  .

17 ASSUMPTIONS All Equity Firm  No External Financing  Constant Return and Cost of Capital  Perpetual Earnings  No Taxes  Constant Retention  Cost of Capital greater than Growth Rate  .

VALUATION Market value of a share is equal to the present value of an infinite stream of dividends to be received by shareholders P  EPS(1  b) /(k  br ) .

10 – (0.15 * 0.6) = Rs 400 P  10(1 – 6) / 0.08 k  0. 0.10 EPS  Rs 10 b  60% P  (1 – 0. 0.EXAMPLE r  0.6) / 0.15.10 – (0.6) / 0.10.6) = Rs 77 19 .08 * 0.10 – (0.6) = Rs 100 P  10(1 – 0.10 * 0.

Ninth Edition © I M Pandey Vikas Publishing House Pvt. Ltd. 20 Growth Firms – Retain all earnings  Normal Firms – Distribute all earnings  Declining Firms – No effect .OPTIMUM PAYOUT RATIO  Financial Management.

Rate at which an investor discounts his dividend stream from a given firm increases with the futurity of dividend stream and hence lowering share prices.THE BIRD IN THE HAND Argument put forward. by Kirshman Investors are risk averters. first of all. They consider distant dividends as less certain than near dividends. .

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 firm earnings which results from its investment policy. under a perfect market situation. dividend decision is of no significance. Thus when investment decision of the firm is given. .MODIGLIANI AND MILLER According to M-M.

23 MARKET IMPERFECTIONS Tax Differential – Low Payout Clientele  Flotation Cost  Transaction and Agency Cost  Information Asymmetry  Diversification  Uncertainty – High Payout Clientele  Desire for Steady Income  No or Low Tax on Dividends  .

dividend action does provide a clear cut means of ‘making a statement’ that speaks louder than a thousand words.INFORMATIONAL CONTENT OF DIVIDEND …. In an uncertain world in which verbal statements can be ignored or misinterpreted. — Solomon .

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