Dividend Policy

Net Profit

Retained Earnings

Dividend

As equity/capital for further investment So Which Route To Go?

Pay out to investor/shareholders

Let's study DIVIDEND POLICY- The Residual Dividend Model

2 Points to consider when distributing Cash to Stockholders

1. Objective: Maximize shareholder value
2. The firms Cash flow belonged to shareholders

Availability & Cost of External Capital

What?

Firm's Investment Opportunities

Residual Dividend Model

Functions?

How?

Firm's Target Capital Structure Manager's Opinion on Investor's Preference of Dividend vs Capital Gains

A method to calculate dividend

Company Shareholders Company uses leftover equity to fund dividend payments Creates volatility in the dividend payments. Results to unstable dividends and fluctuations.

Function???
Develop understanding of the determinants of an

optimal dividend policy, but typically use a computerized financial forecasting model when setting the target payout ratio
To find dividend payout over the forecast period Set up long-run target payout ratios Not a guide to the payout annually

2 ways to make investment grow

Receiving a dividend Increased share prices due to retained earning

Residual Dividend Model

Equation: Dividends = Net Income - Retained earnings required to help finance new investment Dividends = Net Income - Retained Earnings required to help finance new investment

Reminder: Payout Ratio = Dividend/ Net Income

Residual Dividend Policy (Plan)

Determines optimal capital budget. Uses retained earnings to fund the optimal capital budget, paying out leftovers to shareholders. Dollar dividend paid to shareholders fluctuate widely yearly (amount of distributable earnings is not known in advance and is determined as a function of the capital budget) Uses internally generated funds when deciding how to fund optimal capital budget. The residual dividend policy will the firm's cost of capital. Investors do not like unpredictable dividends and will penalize the company.

Conclusion