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Structure 15.1 Introduction 15.2 Traditional Approach 15.3 Dividend Relevance Model 15.3.1 15.3.2 Walter Model Gordon’s Dividend Capitalization Model
15.4 Dividend Irrelevance Theory: Miller and Modigliani Model 15.5 Stability of Dividends 15.6 Forms of Dividends 15.7 Stock Split 15.8 Summary Terminal Questions Answers to SAQs and TQs 15.1 Introduction Dividends are that portion of a firm’s net earnings paid to the shareholders. Preference shareholders are entitled to a fixed rate of dividend irrespective of the firm’s earnings. Equity holders’ dividends fluctuate year after year. It depends on what portion of earnings is to be retained by the firm and what portion is to be paid off. As dividends are distributed out of net profits, the firm’s decisions on retained earnings have a bearing on the amount to be distributed. Retained earnings constitute an important source of financing investment requirements of a firm. However, such opportunities should have enough growth potential and sufficient profitability. There is an inverse relationship between these two – larger retentions, lesser dividends and vice versa. Thus two constituents of net profits are always competitive and conflicting. Dividend policy has a direct influence on the two components of shareholders’ return – dividends and capital gains. A low payout and high retention may have the effect of accelerating earnings growth. Investors of growth companies realize their money in the form of capital gains. Dividend yield will be low for such companies. The influence of dividend policy on future capital gains is to happen in
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Thus. a firm shall have good investment opportunities.2 Traditional Approach This approach is given by B. They clearly emphasize the relationship between the dividends and the stock market. the stock value responds positively Sikkim Manipal University 232 . So there exists a relationship between return on investments r and the cost of capital k. 5. 3. Discuss the effect of declaring dividends on share prices. The modern theories can be grouped as – (a) theories that consider dividend decision as an active variable in determining the value of the firm and (b) theories that do not consider dividend decision as an active variable in determining the value of the firm. We have the traditional theory and new sets of theories based on the relationship between dividend policy and firm value. Some investors prefer current dividends to future gains as prophesied by an English saying – A bird in hand is worth two in the bush. List out the various forms of dividend. Explain the importance of dividends to investors. if no such avenues are forthcoming. In true sense. you should be able to understand the following. 2. L. the dividend decision is a tradeoff between retained earnings and financing decisions. it means that a firm with sufficient investment opportunities will retain the entire earnings to fund its growth avenues. Different theories have been given by various people on dividend policy.Financial Management Unit 15 distant future and therefore by all means uncertain. if the firm can earn a return r higher than its cost of capital k. Dividend policy of a firm is a residual decision. So long as r exceeds k. it will retain its entire earnings and if this source is not sufficient. According to them. debenture issue or term loans. 4. it is a major decision of financial management. it will go in for additional sources in the form of additional financing like equity issue. Graham and D. the firm will payout its entire earnings. 15. Give reasons for stock split. Learning Objectives: After studying this unit. 1. Dodd. Share prices are a reflection of many factors including dividends. That is. Given all these constraints. Conversely. Mention the advantages of a stable dividend policy.
High dividend payout ratio will increase the P/E ratio and low dividend payout ratio will decrease the P/E ratio. if earnings are distributed. that is. its cost of capital k. Walter considers dividend payouts are relevant and have a bearing on the share prices of the firm. E is Earnings per share. Sikkim Manipal University 233 .1 Walter Model Prof. the share values of those companies rises considerably which pay high dividends and the prices fall in the event of low dividends paid. He further states. A company’s share prices may rise in spite of low dividends due to other factors. 15.3 Dividend Relevance Model Under this section we examine two theories – Walter Model and Gordon Model. Drawbacks of the Traditional Approach: As per this approach. James E. Firms which have r>k are called ‘growth firms’ and such firms should have a zero payout ratio. to give a dividend policy that maximizes shareholders’ wealth. P = [m (D+E/3)] Where P is the market price. The firm would have the optimum dividend policy that will enhance the value of the firm. investment policies of a firm cannot be separated from its dividend policy and both are interlinked. This may not always be true. His model clearly establishes a relationship between the firm’s rate of return r. If return on investment r is less than cost of capital k.Financial Management Unit 15 to high dividends and negatively to low dividends. the firm’s earnings can be retained as the firm has better and profitable investment opportunities and the firm can earn more than what the shareholders could by reinvesting. D is dividend per share. This can be studied with the relationship between r and k. If r>k. The choice of an appropriate dividend policy affects the value of the firm.3. the firm should have a 100% payout ratio as the investors have better investment opportunities than the firm. M is the multiplier. Symbolically. there is a direct relationship between P/E ratios and dividend payout ratio. Such a policy will maximize the firm value. 15.
25%. E is Earnings per share. Example: The following information relates to Alpha Ltd. Ke is the cost of capital. D is the dividend per share. · 100% payout or retention: All earnings are either completely distributed or reinvested entirely immediately.Financial Management Unit 15 If a firm has a ROI r equal to its cost of capital k.D / Ke r E ) ] + Ke Ke Where P is the market price per share. 10 ROI (r) may be assumed as follows: 15%. Walter’s Model is based on certain assumptions: · Financing: All financing is done through retained earnings. · Life: The firm has a perpetual life. Walter’s formula to determine the market price is as follows: P = D [ ( . · Constant EPS and DPS: The earnings and dividends do not change and are assumed to be constant forever. 50%. 11% and 8% Show the effect of the dividend policies on the share value of the firm for three different levels of r. · Constant rate of return and cost of capital: The firm’s r and k remain constant and it follows that any additional investment made by the firm will not change the risk and return profile. The dividend payouts can range between zero and 100% and the firm value will remain constant in all cases. g is the growth rate of earnings. r is IRR. taking the DP ratios as zero. 75% and 100% Sikkim Manipal University 234 . Such firms are called ‘normal firms’. Show the effect of the dividend policy on the market price of its shares using the Walter’s Model Equity capitalization rate Ke 11% Earnings per share Rs. the firm’s dividend policy will have no impact on the firm’s value.Retained earnings is the only source of finance available and the firm does not use any external source of funds like debt or new equity.
+ [ . DP = 25% Sikkim Manipal University 235 .44 0 11 . ( )] = 10/0. / 0 11 10 . 10 )] = 13. b. K=11%) a.11 = Rs.11 = Rs.5 0 15 . 10 + [ . DP = 25% c.5 0 11 . 90.91/0. 5 + [ . DP = 100% Case III r<k (r=11%. EPS 10. 2. 90. 10 + [ . )] = 10/0. )] = 10/0. / 0 11 10 .91 0 11 .91 0 11 . b.08 = Rs. DPS=0 P = D [ / Ke ( . DP = 50% d.2 5 5 0 11 . 90.0 0 11 .91 0 11 . g.88 0 08 . DP = 75% e.11 = Rs. DP = 0 0 + [ . / 0 11 10 . 171.Financial Management Unit 15 Solution Ke 11%. ( )] = 10/0. DP = 25% c.10 0 15 .10 0 11 .91 0 11 . / 0 11 10 . 115.73 0 11 .75/0. 90.64/0. ( .2 5 5 0 11 .11 = Rs. 107.2 5 5 0 15 . / 0 11 10 . 5 + [ . DP = 50% d. DP = 0 0 + [ . ( )] = 10/0.91 0 11 .0 0 11 .0 0 15 . 90.81/0. 123. 7. / 0 11 10 .7 5 5 0 11 .D r E )] + Ke Ke Case I r>k (r=15%. / 0 11 10 .97 0 11 . / 0 08 ( .11 = Rs.11 = Rs. 160. ( )] = 10/0. DP = 0 0 + [ . )] = 10.82/0. ( . K=8%) f. 99. 10 . r 15%. )] = 12.11 = Rs. ( )] = 13. / 0 11 10 .17 0 11 . ( )] = 11. + [ . K = 11%) a. / 0 08 ( .73/0. + [ .7 5 5 0 15 . / 0 11 10 . DP = 75% e. 2. 90. + [ .11 = Rs. / 0 11 10 .91 0 11 . 2. 7.08 = Rs. DP = 100% Case II r = k (r = 11%. ( .13 0 08 . + [ .11 = Rs. ( .11 = Rs. )] = 12.
market value of shares decline. Assumptions · · All equity firm: The firm is an all equity firm with no debt. )] = 10.5 0 11 . the market price of a share increases as the DP increases. Ke is also assumed to be constant and this ignores the business risk of the firm which has a direct impact on the firm value. + [ . Market value of share is highest when DP is zero and least when DP is 100%. / 0 08 ( . / 0 08 ( . 7.95 0 08 . When r=k.94/0.7 5 5 0 11 . that is. Finally.3. 99. 10 . the market value of share is constant irrespective of the DP ratio.08 = Rs. in growth firms.08 = Rs.2 Gordon’s Dividend Capitalization Model Gordon also contends that dividends are relevant to the share prices of a firm. 107. 10 )] = 11. 3. 10 )] = 10/0. There is a positive correlation between the two. This model is applicable only to allequity firms. · · · · Constant return r Constant cost of capital Ke The life of the firm is indefinite. when r<k.Financial Management Unit 15 h. 2. DP= 100% 10 + [ . as the DP increases. DP = 75% 5 + [ . Constant retention ratio: The retention ratio g=br is constant forever. In the third situation.43 0 08 .08 = Rs.10 0 11 . 236 Sikkim Manipal University . in declining firms. When r>k. / 0 08 ( .91 0 08 . 90. Interpretation: The above workings can be summarized as follows: 1. Myron Gordon uses the Dividend Capitalization Model to study the effect of the firm’s dividend policy on the stock price. Limitations Walter has assumed that investments are exclusively financed by retained earnings and no external financing is used.88/0. DP = 50% i. 15. It is not affected whether the firm retains the profits or distributes them. the value of shares is inversely related to DP ratio. Secondly r is assumed to be constant which again is not a realistic assumption. No external financing is used and only retained earnings are used to finance any expansion schemes. j.
The shareholders therefore prefer current dividends to avoid risk. calculate the stock value of Mahindra Tech. Gordon’s model can be symbolically expressed as: P= E 1 .Financial Management Unit 15 · Cost of capital greater than br. Investors prefer to pay higher price for stocks which fetch them current dividend income. Gordon explains his theory with preference for current income. Retained earnings are evaluated by the shareholders as risky and therefore the market price of the shares would be adversely affected. Example: Given Ke as 11%. for (a) r=12%. E is Earnings Per Share. they discount future dividends. K=11%) P = E(1—b) Ke—br Sikkim Manipal University 237 . (1 – b) is dividend payout ratio.br Where P is the price of the share. br is growth rate in the rate of return on investment. In other words. that is Ke>br Gordon’s model assumes investors are rational and riskaverse. Ke is cost of equity capital.b ( ) Ke . E is Rs. They prefer certain returns to uncertain returns and therefore give a premium to the constant returns and discount uncertain returns. (b) r=11% and (c) r=10% for various levels of DP ratios given under: DP ratio (1 – b) Retention ratio A B C D E 10% 20% 30% 40% 50% 90% 80% 70% 60% 50% Solution Case I r>k ( r=12%. b is Retention raio. 10.
12) c. 90.002 = Rs. 90.6) 0. b 90% 10(1—0. 500 Sikkim Manipal University 238 .11) c. b 50% 10(1—0.12) e.011 = Rs.044 = Rs.6*0.038 = Rs. b 70% 10(1—0. DP 40%.11(0. 90.Financial Management Unit 15 a. DP 30%.7) 0. DP 20%.6*0. 90. DP 50%.9) 0.11(0.12) b.91 equals 1/.8) 0.11) b.8*0.9) 0.5) 0. DP 20%.8*0.11(0. DP 10%.014 = Rs.033 = Rs. 105.022 = Rs.26 equals 3/. b 60% 10(1—0.7*0. DP 10%. b 80% 10(1—0.11(0.026 = Rs.12) d.9*0.05 = Rs.11) equals 4/. 142.11) d.11(0.86 equals 1/. b 90% 10(1—0.91 equals 3/.91 equals 2/. b 60% 10(1—0.9*0. 100 equals 4/.11(0.7) 0. DP 40%.11(0. b 80% 10(1—0.11(0.6) 0. DP 30%.11(0. 115.91 equals 5/.8) 0. K=11%) P = E(1—b) Ke—br a.5*0.38 equals 2/.12) Case II r=k ( r=11%. b 70% 10(1—0.7*0.
6) 0. Market value of share is highest when DP is least and retention highest. It is not affected whether the firm retains the profits or distributes them.11) Case III r<k ( r=10%. 2.11(0. the market value of share is constant irrespective of the DP ratio. b 90% 10(1—0.02 = Rs. 66. 75 equals 2/.06 = Rs. 83. 50 equals 5/.55 = Rs.91 Sikkim Manipal University 239 . the firm’s value decreases with an increase in payout ratio.33 equals 4/.5*0.1) c.11(0.Financial Management Unit 15 e. b 50% 10(1—0.1) d. When r>k. DP 50%. market value of share increases with an increase in DP ratio. K=11%) P = E(1—b) Ke—br a.8*0.6*0. DP 10%. DP 50%.8) 0. DP 30%.7) 0. DP 20%.67 equals 1/.11(0.05 = Rs.1) Interpretation: Gordon is of the opinion that dividend decision does have a bearing on the market price of the share. 90.5*0. b 70% 10(1—0.1) b. b 80% 10(1—0.03 = Rs.04 = Rs. 3. When r<k.9*0. 1. equals 5/. 80 equals 3/. When r=k. b 50% 10(1—0.7*0.11(0. DP 40%.11(0.5) 0.9) 0.5) 0.1) e. b 60% 10(1—0.11(0.
D1 is dividends to be paid at the end of period 1. P0 = 1 (1+Ke) Where P0 is the current market price. dropped at a later stage.Financial Management Unit 15 15. securities are infinitely divisible and no single investor is large enough to influence the share value. This makes the investor indifferent to dividend earnings and capital gains as the share value is more dependent on the future earnings of the firm than on its current dividend policy. The arbitrage process will neutralize the increase in share value (due to dividends) with the issue of new shares. This assumption was. Symbolically. P1 is market price at the end of period 1. · No Risk – Certainty about future investments. implying there is no difference between capital gains and dividends.4 Miller and Modigliani Model The MM hypothesis seeks to explain that a firm’s dividend policy is irrelevant and has no effect on the share prices of the firm. There are no floatation or transaction costs. This model advocates that it is the investment policy through which the firm can increase its share value and hence this should be given more importance. The arbitrage process refers to setting off or balancing two transactions which are entered into simultaneously. Ke is the cost of equity capital. Sikkim Manipal University * (D1 + P1) 240 . dividends and profits of the firm. · Constant investment policy: The investment policy of the company does not change. Assumptions · Existence of perfect capital markets: All investors are rational and have access to all information free of cost. however. The two transactions are paying out dividends and raising external funds to finance additional investment programs. Based on the above assumptions. the model is given as: Step I: The market price of a share in the beginning is equal to the PV of dividends paid and market price at the end of the period. Miller and Modigliani have explained the irrelevance of dividend as the crux of the arbitrage argument. it will have to raise capital by selling new shares for financing activities. If the firm pays out dividend. · No taxes: There are no taxes. The implication is that there is no change in the business risk position and the rate of return.
E is earnings during the period. new shares are issued at the end of year 1 at price P1.Financial Management Unit 15 Step II: Assuming there is no external financing. nD1 is total dividends paid. n1P1 = I—(E—nD1) which can be written as n1P1 = I—E + nD1 Where I is total investment required. 100 each. The capitalized value of the dividends to be received during the period plus the value of the number of shares outstanding is less than the value of new shares. Step III: If the firm’s internal sources of financing its investment opportunities fall short of funds required. 4 per share. It currently has outstanding shares worth 25000 shares selling currently at Rs. 600000 to fund its investment requirement. that is. The firm expects to have a net income of Rs. nP0 = = 1 (1+Ke) Firms will have to raise additional capital to fund their investment requirements after utilizing their retained earnings. The company also requires Rs. Show that under MM model. the dividend payment does not affect the value of the firm. (E—nD1) is retained earnings. 400000 for the current financial year and it is contemplating to pay a dividend of Rs. the value of the firm is: nP0 = = 1 (1+Ke) Where n is number of shares outstanding. Solution Case I: When dividends are paid: Step I: P0 = 1 (1+Ke) * (D1 + P1) 1 * (nD1 + (n + n1)P1 –I + E—nD1) (1+Ke) * (nD1 + (n + n1)P1 – n1p1) * (nD1 + nP1) Sikkim Manipal University 241 . Step IV: The value of share is thus: nP0 = = Example: A company has a capitalization rate of 10%.
Financial Management Unit 15 100 = 1/(1+0. brokerage and other costs. Critical Analysis of MM Hypothesis: Floatation costs: Miller and Modigliani have assumed the absence of floatation costs. 300000 Step III: Number of additional shares to be issued 300000/106 = 2831 shares Step IV: The firm value nP0 = = (n + n1)P1 –I + E (1+Ke) (25000 + 2831)*106—600000 + 400000 equals Rs. Floatation costs refer to the cost involved in raising capital from the market.1) * (4 + P1) P1 = Rs. 106 Step II: n1P1 = I—(E—nD1). the value of the firm remains the same in both the cases whether or not dividends are declared. 110 Step II: n1P1 = I—(E—nD1).1) Case II: When dividends are not paid: Step I: P0 = 1 (1+Ke) 100 = 1/(1+0. 2500000 (1+0. These costs ordinarily account to around 10% Sikkim Manipal University * (D1 + P1) 242 . nD1 is 25000*4 n1P1 = 600000—(400000—100000)=Rs. that is.1) * (0 + P1) P1 = Rs. nD1 is 25000*4 n1P1 = 600000—(400000—0)=Rs. 2500000 (1+0.1) Thus. the costs incurred towards underwriting commission. 200000 Step III: Number of additional shares to be issued 200000/110 = 1819 shares Step IV: The firm value nP0 = = (n + n1)P1 –I + E (1+Ke) (25000 + 1819)*110—600000 + 400000 equals Rs.
100 and floatation costs are 12%. It implies that Rs. it should sell shares at a price lesser than the prevailing market price to attract new shareholders. Sikkim Manipal University 243 . This theory implies that if the company does not pay dividends. The steadiness is a sign of good health of the firm and may take any of the following forms – (a) constant dividend per share. given the presence of floatation costs. These are the costs associated with sale of securities by investors. the investors desirous of current income sell part of their holdings without any cost incurred. 88. a firm pays a fixed amount of dividend per share year after year. the firm should sell more shares to replace the dividend amount.Financial Management Unit 15 15% of the total issue and they cannot be ignored given the enormity of these costs. the firms should depend on retained earnings and low payout ratio to fuel such opportunities. This is very unrealistic as the sale of securities involves cost. In such cases. For example. Underpricing of shares: If the company has to raise funds from the market. Generally.5 Stability of Dividends Stability of dividends is the consistency in the stream of dividend payments. 10 per share. As and when the firm starts earning a higher amount of revenue it will consider payment of higher dividends and in future it is expected to maintain the higher level. a firm following such a policy will continue payments even if it incurs losses. External financing is definitely costlier than retained earnings. The presence of these costs affects the balancing nature of retained earnings and external financing. In such years when there is a loss. For instance. Market conditions: If the market conditions are bad and the firm has some lucrative opportunities. investors wishing to get current income should sell higher number of shares to get the income they are to receive. (b) constant DP ratio and (c) constant dividend per share plus extra dividend. the net proceeds are only Rs. it is not worthapproaching new investors at this juncture. if a share is issued worth Rs. 2.50 is paid out every year irrespective of its earnings. It is the payment of certain amount of minimum dividend to the shareholders. Transaction costs: This is another assumption made by MM that there are no transaction costs like brokerage involved in capital market. This follows that at lower prices. a firm may have a policy of paying 25% dividend per share on its paidup capital of Rs. 15. the amount accumulated in the dividend equalization reserve is utilized. Constant dividend per share: As per this form of dividend policy.
Of these. etc. · Raise additional finance: Shares of a company with stable and regular dividend payments appear as quality investment rather than a speculation. youngsters. a firm usually pays a fixed dividend ordinarily and in years of good profits. Investors of such companies are known for their loyalty and whenever the firm comes with new issues. they get higher amount. Such shares will not have wide fluctuations in the market prices which is good for investors. A constant dividend policy will not have any fluctuations suggesting to the investors that the firm’s future is bright. people like retired persons prefer current income. salaried class. may necessitate sale of shares. In contrast. that is. pensioners. it implies that shareholders get 25% of earnings as dividend year after year. Dividend decision is a sign of firm’s prosperity and hence firm should have a stable DP. firms follow a stable DP. GIC and MF prefer to invest in companies which have a record of stable DP. Sharp changes in current income. Thus raising additional funds becomes easy. shareholders of a firm having an unstable DP will not be certain about their future in such a firm. Constant dividend per share plus extra dividend: Under this policy. For example. the firm pays a constant percentage of net earnings to the shareholders. if the firm fixes its DP ratio as 25% of its earnings. · Institutional investors’ requirements: Institutional investors like LIC. The stability of dividends is desirable because of the following advantages: · Build confidence amongst investors: A stable dividend policy helps to build confidence and remove uncertainty in the minds of investors. Sikkim Manipal University 244 . they are more responsive and receptive. dividends. In such years where profits are high. additional or extra dividend is paid over and above the regular dividend. Thus to attract these organizations having large quantities of investible funds. Stable dividend policy avoids sale of securities and inconvenience to investors. · Information about firm’s profitability: Investors use dividend policy as a measure of evaluating the firm’s profitability. · Investors’ desire for current income: A firm has different categories of investors – old and retired persons. · Stability in market price of shares: The market price of shares varies with the stability in dividend rates. housewives. A company having erratic DP is not preferred by these institutions.Financial Management Unit 15 Constant DP ratio: With this type of DP policy. Their living expenses are fairly stable from one period to another.
If a firm has a ROI r equal to its cost of capital k. 8. 4. as known is USA or bonus shares in India. equity shareholders are issued transferable promissory notes with shorter maturity periods which may or may not have interest bearing. dividends are distributed in cash. 2.Financial Management Unit 15 Self Assessment Questions I 1. 6.6 Forms of Dividends Dividends are that potion of earnings available to shareholders. This form is adopted if the firm has earned profits and it will take some time to convert its assets into cash (having more of current sales than cash sales). 3. ______________are the costs associated with sale of securities by investors. 7. whereas scrip dividends carry shorter maturity and may or may not carry interest. especially the old and retired investors depend on this form of payment for want of current income. ______________considers dividend payouts are relevant and have a bearing on the share prices of the firm. The __________process refers to setting off or balancing two transactions which are entered into simultaneously. This has the effect of increasing the number of outstanding shares of the firm. This decision has the effect of Sikkim Manipal University 245 . The investors also. Dividend policy has a direct influence on the two components of shareholders’ return__________ and ____________. Bond dividends carry longer maturity period and bear interest. · Scrip dividend: In this form of dividends. Generally. · Bond dividend: Scrip and bond dividend are the same except that they differ in terms of maturity. it is called a ___________ 5. __________ costs refer to the cost involved in raising capital from the market. · Stock dividend (Bonus shares): Stock dividend. but sometimes they may also declare dividends in other forms which are discussed below: · Cash dividends: Most companies pay dividends in cash. 15. Payment of dividend in this form is done only if the firm is suffering from weak liquidity position. is the distribution of additional shares to the shareholders at no additional cost. The reserves and surplus (retained earnings) are capitalized to give effect to bonus issue. ____________constitute an important source of financing investment requirements of a firm. ________ model explains that consumers prefer certain returns to uncertain returns and therefore give a premium to the constant returns and discount uncertain returns.
· Indication of higher future profits: Share split is generally considered a method of management communication to investors that the company is expecting high profits in future.8 Summary Dividends are the earnings of the company distributed to shareholders. They associate it with prosperity. Dodd are of the view that there is a close relationship between the dividends and the stock market. A stock split affects only the par value and does not have any effect on the total amount outstanding in share capital. transfer from reserves to share capital not changing the total net worth. If the company follows a system of stable dividend per share. Payment of dividend is not mandatory. Splitting the shares will place them in more popular trading range thus providing marketability and motivating small investors to buy them. L. The investors are allotted shares in proportion to their present shareholding. The reasons for splitting shares are: · To make shares attractive: The prime reason for effecting a stock split is to reduce the market price of a share to make it more attractive to investors. Sikkim Manipal University 246 .7 Stock Split A stock split is a method to increase the number of outstanding shares by proportionately reducing the face value of a share. Prof. Walter considers dividend payouts are necessary but if the firm’s ROI is high. Shares of some companies enter into higher trading zone making it out of reach to small investors. what should be the quantum of payment?” Various theories have come out with various suggestions on the payment of dividend. The stock value responds positively to high dividends and vice versa. As payment of dividend is not compulsory. earnings can be retained as the firm has better and profitable investment opportunities. James E. the question which arises in the minds of policy makers is “Should dividends be paid.Financial Management Unit 15 recapitalization. Graham and D. B. Declaration of bonus shares has a favourable psychological effect on investors. but most companies see to it that dividends are paid on a regular basis to maintain the image of the company. the investors would surely get higher dividends with stock split. the company does not resort to reducing the cash dividends. 15. · Higher dividend to shareholders: When shares are split. that is. if yes. 15.
Dividends can be paid out in various forms such as cash dividend. 120 lakhs 12.Financial Management Unit 15 Gordon also contends that dividends are significant to determine the share prices of a firm. Considering the following information. dividend payout ratio is 50%. Shareholders prefer certain returns (current) to uncertain returns (future) and therefore give a premium to the constant returns and discount uncertain returns. growth rate in the ROI is 15%. Miller and Modigliani explain that a firm’s dividend policy is irrelevant and has no effect on the share prices of the firm.5. bond dividend and bonus shares. Equity capitalization 15% EPS Rs. cost of equity is 20%. what is the value of the stock as per Gordon’s Dividend Equalization Model? 6. of equity shares Cost of equity shares Retention ratio ROI Rs. Write a short note on the different types of dividend.5% Rs. scrip dividend. 2. What is the value of the stock as per Gordon Model? Sikkim Manipal University 247 . what is the price of the share as per Gordon’s Model? Net sales Net profit margin Outstanding preference shares No. makes the following information available. They are of the view that it is the investment policy through which the firm can increase its share value and hence this should be given more importance. 50 lakhs @ 12% dividend 250000 12% 40% 16% 5. Terminal Questions 1. 25 Dividend payout ratio25% ROI 12% What is the price of the share as per Walter Model? 4. The following information is available in respect of a company. What is stock split? What are its advantages? 3. If the EPS is Rs. Nile Ltd.
7 : Hint: Apply the Gordon formula of P = E(1—b) Ke—br Sikkim Manipal University 248 . 20. Transaction costs Answers to Terminal Questions: 1. 6. Retained earnings 2.Financial Management Unit 15 Ke 14%. Refer to10. ROI 16% 7. Prof. Walter 4. Refer to10. Hint: Apply the formulaWalter’s formula to determine the market price P = D + [r(E—D)/Ke] Ke Ke 4. Gordon 6. 5.6 2. James E. Dividends and capital gains 3. Floatation costs 8. EPS Rs. Arbitrage 7.7 3. Normal firm 5. What is the stock price as per Gordon Model if DP ratio is 60% in the above case? Answers to Self Assessment Questions Self Assessment Questions 1 1. D/P ratio 35% Retention ratio 65%.
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