Financial Management Notes - Dividend Decision - Dynamic Tutorials and Services

1/26/2021 Financial Management Notes: Dividend Decision - Dynamic Tutorials and Services
MULTIPLE CHOICE QUESTIONS SOLVED PAPERS IMPORTANT QUESTIONS SEBA 9 &10 UGC-NET CONTACT US     
HOME | DIBRUGARH UNIVERSITY  | GAUHATI UNIVERSITY | ASSAM UNIVERSITY | AHSEC | IGNOU | M.COM | NIOS
 BREAKING NEWS COST ACCOUNTING Reconciliation of Cost and Financial Accounting | Expenses Excluded From Cost Accounts | Expenses Shown in Cost Acco
OTHER SERVICES AND BLOGS OF DYNAMIC TUTORIALS AND SERVICES

MUMBAI UNIVERSITY SOLVED QUESTION PAPERS S TAY C O N N E C T E D
B.COM 2ND AND 4TH SEM E-BOOK: NOW YOU CAN PAY AND DOWNLOAD EBOOK FOR 6TH SEM
B.COM 3RD SEM (HONS & NON-HONS) NEW SYLLABUS UNDER CBCS PATTERN Enter your email address:
B.COM 1ST SEM (HONS & NON-HONS) NEW SYLLABUS UNDER CBCS PATTERN
Subscribe
FOLLOW OUR YOUTUBE CHANNLE FOR LATEST VIDEOS AND IMPORTANT QUESTIONS
Delivered by FeedBurner
DYNAMIC TUTORIALS AND SERVICES MOBILE APP NOW AVAILABLE IN GOOGLE PLAY STORE
OUR WEBSITE FOR ENGLISH AND ALTERNATIVE ENGLISH NOTES AND SOLVED PAPERS
SPONSORED SEARCHES
dividend stocks to buy dividend returns
business nancial management dividend companies
Home / dibrugarh university notes / Financial Management Notes / semester III / Financial Management Notes: Dividend
Decision
Financial Management Notes: Dividend Decision

by Kumar Nirmal Prasad on October 23, 2018 in dibrugarh university notes, Financial Management Notes, semester III
Unit – IV: Dividend Decisions FEATURED POST AHSEC SOLVED PA

Meaning of Dividend and Dividend Policy Business Statistics Notes | B.Com Notes | CBCS P
Meaning of Dividend: A dividend is that portion of pro ts and surplus funds of a company which has
| Business Statistics MCQs | For BCOM, BBA, MCO
actually set aside by a valid act of the company for distribution among its shareholders.
and MBA
BUSINESS STATISTICS NOTES B.COM NOTES
According to ICAI, “Dividend is the distribution to the shareholders of a company from the reserves and PER CBCS PATTERN USEFUL FOR B.COM, BBA
MBA AND UGC NET
pro ts.”
In the words of S.M. Shah, “Dividend is a part of divisible pro ts of a business company which is distributed
to the shareholders.”
Dividend may be divided into following categories:
1. Cash Dividend.
2. Stock Dividend or Bonus Dividend.
3. Bond Dividend.
4. Property Dividend. CMA COURSE DIBRUGARH UNIVER

5. Composite Dividend.  CMA FOUNDATION
6. Interim Dividend.  CMA FOUNDATION SOLVED PAPERS
7. Special or Extra Dividend.  CMA FOUNDATION SYLLABUS
8. Optional Dividend.  CMA IMPORTANT TOPICS
Some of these are explained below:  CMA INTERMEDIATE NOTES
CASH DIVIDEND: A Cash dividend is the most common form of the dividend. The shareholders are paid in  CMA JOB OPPORTUNITIES
cash per share. The board of directors announces the dividend payment on the date of declaration. The dividends  CMA QUESTION PAPER PATTERN
are assigned to the shareholders on the date of record. The dividends are issued on the date of payment. But for
 CMA SYLLABUS
distributing cash dividend, the company needs to have positive retained earnings and enough cash for the
payment of dividends.
POPULAR POSTS
https://www.dynamictutorialsandservices.org/2018/10/financial-management-notes-dividend.html 1/10
BONUS SHARE: Bonus share is also called as the stock dividend. Bonus shares are issued by the company Auditing Multiple Choice Questions and Answers | Auditin
when they have low operating cash, but still want to keep the investors happy. Each equity shareholder receives a
For CA, CS and CMA Exams | Principle of Auditing MCQs
certain number of additional shares depending on the number of shares originally owned by the shareholder. For
Corporate Accounting Multiple Choice Questions and Answ
example, if a person possesses 10 shares of Company A, and the company declares bonus share issue of 1 for Upcoming Exam | Company Accounts MCQs
every 2 shares, the person will get 5 additional shares in his account. From company’s angle, the no. of shares and
issued capital in the company will increase by 50% (1/2 shares). The market price, EPS, DPS etc will be adjusted AHSEC Class 12: Accountancy Solved Question Papers' 20
AHSEC | SOLVED QUESTION PAPERS
accordingly.
INTERIM DIVIDEND: This dividend is issued between two accounting year on the basis of expected pro t. Di erence between Equity Shares and Preference Shares
This dividend is declared before the preparation of nal accounts.
Shares vs Preference Shares
PROPERTY DIVIDEND: The company makes the payment in the form of assets in the property dividend. The MCQ - Business Economics | Managerial Economics Multip
asset could be any of this equipment, inventory, vehicle or any other asset. The value of the asset has to be Choice Questions | Business Economics Quiz
restated at the fair value while issuing a property dividend.
AHSEC Class 12: Accountancy Solved Question Papers' 20
SCRIP DIVIDEND: Scrip dividend is a promissory note to pay the shareholders later. This type of dividend is AHSEC | SOLVED QUESTION PAPERS
used when the company does not have su cient funds for the issuance of dividends.
Business Economics: Meaning, Nature, Scope and Objectiv
LIQUIDATING DIVIDEND: When the company returns the original capital contributed by the equity Managerial Economics Nature and Scope
shareholders as a dividend, it is termed as liquidating dividend. It is often seen as a sign of closing down the
company. AHSEC Class 12: Accountancy Solved Question Papers' 20
AHSEC | SOLVED QUESTION PAPERS
Meaning of Dividend Policy: A policy which determines the amount of earnings to be distributed to the
shareholders and the amount to be retained in the company as retained earnings, is called dividend policy. In T O TA L PAG E V I E W S
short, dividend policy determines the division of earnings between payment to shareholders and retained
earnings.
Types of Dividend Policy 2 5 2 0 1 0 8 9

Every company which is listed and is making pro ts has to take the decision regarding the distribution of
72 Online Users
pro ts to its shareholders as they are the ones who have invested their money into the company. This distribution
of pro ts by the company to its shareholders is called dividend in nance parlance, every company has di erent B LO G P R O T E C T I O N
objectives and methods and dividend is no di erent and that is the reason why di erent companies follow
di erent dividend policies, let’s look at various types of dividend policies:
1) Regular dividend policy: Under this type of dividend policy a company has the policy of paying dividends
to its shareholders every year. When the company makes abnormal pro ts then the company will not pay that B LO G A R C H I V E
extra pro ts to its shareholders completely rather it will distribute lower pro t in the form of the dividend to the
shareholders and keep the excess pro ts with it and suppose a company makes loss then also it will pay dividend October (68)
to its shareholders under regular dividend policy. This type of dividend policy is suitable for those companies which
have constant cash ows and have stable earnings. Investors like retired person and conservative investors who
prefer safe investment and constant income will invest in constant dividend paying companies.
2) Stable Dividend Policy: Stability of dividends means regularity in payment of dividends. It refers to the
consistency in stream of dividends. In short, we can say that a stable dividend policy is a long term policy which is
not a ected by the variations in the earnings during di erent periods. The stability of dividends can take any one of
the three forms:
a) Constant D/P ratio.
b) Constant dividends per share.
c) Constant dividend per share plus extra dividends.
Merits of Stable Dividend Policy: Following are some of the advantages of a stable dividend policy:
a) This policy contributes to stablise market value of company’s equity shares at a high level.
b) This policy helps the company is mobilizing additional funds in the form of additional equity shares.
c) Regular earnings in the form of dividend satisfy investors.
d) This policy encourages shareholders to hold company’s share for longer time and simultaneously other
investors are also attracted for the purchase of shares.
e) This policy is helpful for expansion and growth prospects of a company.
f) This policy encourages the institutional investors because they like to invest in those companies which
make uninterrupted payment of dividends.
Demerits of Stable Dividend Policy: Following are some of the disadvantages of a stable dividend policy:
a) Sometime despite of large earnings, management decides not to declare dividends.
b) In this policy, instead of paying dividend in cash, bonus share are issued to the shareholders.
c) This policy is used to capitalise reinvested earnings of the rm.
3) Irregular dividend policy: Under this type of policy there is no mandate to give dividends to shareholders
of the company and top management gives it according to its own free will, so suppose company has some
abnormal pro ts then management may decide to pass it fully to its shareholders by giving interim dividend or
management may decide to use it for future business expansion. Companies which have irregular earnings, lack of
liquidity and are afraid of committing itself for paying regular dividends adopt irregular dividend policy.
4) No dividend policy: Under this policy company pays no dividend to its shareholders, the reason for
following this type of policy is that company retains the pro t and invest in the growth of the business. Companies
which have ample growth opportunities follow this type of policy and shareholders who are looking for growth
invest in these types of companies because there is plenty of scope of capital appreciation in these stocks and if the
company is successful then capital appreciation will outdo regular dividend income as far as shareholders are
concerned.
Factors In uencing Dividend Decision
There are various factors which a ect dividend decision. These are enumerated below with brief
explanation.
a) Legal position: Section 205 of the Companies Act, 1956 which lays down the sources from which
dividend can be paid, provides for payment of dividend (i) out of past pro ts and (ii) out of moneys provided by the
Central/State Government, apart from current pro ts. Thus, by law itself, a company may be allowed to declare a
dividend even in a year when the pro ts are inadequate or when there is absence of pro t.
b) Magnitude and Trend in EPS: EPS is the basis for dividend. The size of the EPS and the trend in EPS in
recent years set how much can be paid as dividend a high and steadily increasing EPS enables a high and steadily
increasing DPS. When EPS uctuates a di erent dividend policy has to be adopted.
c) Taxability: According to Section 205(3) of the Companies Act, 1956 'no dividend shall be payable except
in cash'. However, the Income-Tax Act de nes the term dividend so as to include any distribution of property or
rights having monetary value. Therefore liberal dividend policy becomes unattractive from the point of view of the
shareholders/investors in high income brackets. Thus a company which considers the taxability of its shareholders,
may not declare liberal dividend though there may be huge pro t, but may alternatively go for issuing bonus
shares later.
d) Liquidity and Working Capital Position: Apparently, distribution of dividend results in out ow of cash
and as such a reduction in working capital position. Even in a year when a company has earned adequate pro t to
warrant a dividend declaration, it may confront with a week liquidity position. Under the circumstance, while one
company may prefer not to pay dividend since the payment may impair liquidity, another company following a
stable dividend policy, may wish to declare dividends even by resorting to borrowings for dividend payment in
cash.
e) Impact on share price: The impact of dividends on market price of shares, though cannot be precisely
measured, still one could consider the in uence of dividend on the market price of shares. The dividend policy
pursued by a company naturally depends on how far the management is concerned about the market price of
shares. Generally, an increase in dividend payout results in a hike in the market price of shares. This is signi cant as
it has a bearing on new issues.
f) Control consideration: Where the directors wish to retain control, they may desire to nance growth
programmes by retained earnings, since issue of fresh equity shares for nancing growth plan may lead to dilution
of control of the dominating group. So, low dividend payout is favoured by Board.
g) Type of Shareholders: When the shareholders of the company prefer current dividend rather man
capital gain a high payment is desirable. This happens so, when the shareholders are in low tax brackets, they are
less moneyed and require periodical income or they have better investment avenues than the company. Retired
persons, economically weaker sections and similarly placed investors prefer current income i.e. dividend. If, on the
other hand, majority of the shareholders are moneyed people, and want capital gain, then low payout ratio is
desirable. This is known as clientele e ect on dividend decision.
h) Industry Norms: The industry norms have to be adhered to the extent possible. It most rms in me
industry adopt a high payout policy, perhaps others also have to adopt such a policy.
i) Age of the company: Newly formed companies adopt a conservative dividend policy so that they can get
stabilized and think of growth and expansion.
j) Investment opportunities for the company: If the company has better investment opportunities, and it
is di cult to raise fresh capital quickly and at cheap costs, it is better to adopt a conservative dividend policy. By
better investment opportunities we mean those with higher 'r' relative to the 'k'. So, if r>k, low payout is good. And
vice versa.
k) Restrictive covenants imposed by debt nanciers: Debt nanciers, especially term lending nancial
institutions, may impose restrictive conditions on the rate, timing and form of dividends declared. So, that
consideration is also signi cant.
l) Floatation cost, cost of fresh equity and access capital market: When oatation costs and cost of fresh
equity are high and capital market conditions are not congenial for a fresh issue, a low payout ratio is adopted.
m) Financial signaling: Dividends are the best medium to tell shareholder of better days ahead of the
company. When a company enhances the target dividend rate, it overwhelmingly signals the shareholders that
their company is on stable growth path. Share prices immediately react positively.
Modigliani and Miller approach (M & M Hypothesis)
The residuals theory of dividends tends to imply that the dividends are irrelevant and the value of the rm
is independent of its dividend policy. The irrelevance of dividend policy for a valuation of the rm has been most
comprehensively presented by Modigliani and Miller. They have argued that the market price of a share is a ected
by the earnings of the rm and not in uenced by the pattern of income distribution. What matters, on the other
hand, is the investment decisions which determine the earnings of the rm and thus a ect the value of the rm.
They argue that subject to a number of assumptions, the way a rm splits its earnings between dividends and
retained earnings has no e ect on the value of the rm.
Like several nancial theories, M&M hypothesis is based on the argument of e cient capital markets. In
addition, there are two options:
(a) It retains earnings and nances its new investment plans with such retained earnings;
(b) It distributes dividends, and nances its new investment plans by issuing new shares.
The intuitive background of the M&M approach is extremely simple, and in fact, almost self explanatory. It is
based on the following assumptions:
a) The capital markets are perfect and the investors behave rationally.
b) All information is freely available to all the investors.
c) There is no transaction cost.
d) Securities are divisible and can be split into any fraction. No investor can a ect the market price.
e) There are no taxes and no otation cost.
f) The rm has a de ned investment policy and the future pro ts are known with certainty. The
implication is that the investment decisions are una ected by the dividend decision and the operating cash ows
are same no matter which dividend policy is adopted.
Their conclusion is that, the shareholders get the same bene t from dividend as from capital gain through
retained earnings. So, the division of earnings into dividend and retained earnings does not in uence shareholders'
perceptions. So whether dividend is declared or not, and whether high or low payout ratio is follows, it makes no
di erence on the value of the share. In order to satisfy their model, MM has started with the following valuation
model.
P0= 1* (D1+P1)/ (1+ke)
Where,
P0 = Present market price of the share
Ke = Cost of equity share capital
D1 = Expected dividend at the end of year 1
P1 = Expected market price of the share at the end of year 1
SPONSORED SEARCHES
expected dividend method bcom 6th semester dividend theory
dividend stocks to buy business nancial management
With the help of this valuation model we will create a arbitrage process, i.e., replacement of amount paid as
dividend by the issue of fresh capital. The arbitrage process involves two simultaneous actions. With reference to
dividend policy the two actions are:
a) Payment of dividend by the rm
b) Rising of fresh capital.
With the help of arbitrage process, MM have shown that the dividend payment will not have any e ect on
the value of the rm. Even if the rm pays dividends, resulting in a increase in market value of the share, the e ect
on the value of the rm will be neutralized by the decrease in terminal value of the share.
Criticisms on MM Dividend theory: MM theory is criticized on the invalidity of most of its assumptions.
Some of the criticisms are presented below:
a) First, perfect capital market is not a reality.

b) Second, transaction and oatation costs do exist.
c) Third, Dividend has a signaling e ect. Dividend decision signals nancial standing of the business,
earnings position of the business, and so on. All these are taken as uncertainty reducers and that these in uence
share value. So, the stand of MM is not tenable.
d) Fourth, MM assumed that additional shares are issued at the prevailing market price. It is not so. Fresh
issues - whether rights or otherwise, are made at prices below the ruling market price.
e) Fifth, taxation of dividend income is not the same as that of capital gain. Dividend income upto Rs.
10000 is fully exempt, whereas capital gain attracts a at 20% tax in the case of individual assesses. So, investor
preferences between dividend and capital gain di er.
f) Sixth, investment decisions are not always rational. Some, sub-marginal projects may be taken up by
rms if internally generated funds are available in plenty. This would de ate ROI sooner than later reducing share
price.
g) Seventh, investment decisions are tied up with nancing decisions. Availability of funds and external
constrains might a ect investment decisions and rationing of capital, then becomes a relevant issue as it a ects
the availability of funds.
Walter’s Dividend theory
Professor James E. Walter argues that the choice of dividend policies almost always a ects the value of the
enterprise. His model shows clearly the importance of the relationship between the rm’s internal rate of return (r)
and its cost of capital (k) in determining the dividend policy that will maximise the wealth of shareholders.
Valuation Formula and its Denotations: Walter’s formula to calculate the market price per share (P) is:
P = D/k + {r*(E-D)/k}/k, where
P = market price per share
D = dividend per share
E = earnings per share
r = internal rate of return of the rm
k = cost of capital of the rm
Explanation: The mathematical equation indicates that the market price of the company’s share is the total
of the present values of:
a) An in nite ow of dividends, and
b) An in nite ow of gains on investments from retained earnings.
The formula can be used to calculate the price of the share if the values of other variables are available.
Walter’s model is based on the following assump ons:
a) The rm nances all investment through retained earnings; that is debt or new equity is not issued;
b) The rm’s internal rate of return (r), and its cost of capital (k) are constant;
c) All earnings are either distributed as dividend or reinvested internally immediately.
d) Beginning earnings and dividends never change. The values of the earnings per share (E), and the
divided per share (D) may be changed in the model to determine results, but any given values of E and D are
assumed to remain constant forever in determining a given value.
e) The rm has a very long or in nite life.
Criticism of Walter’s theory:
Walter’s model is quite useful to show the e ects of dividend policy on an all equity rm under di erent
assumptions about the rate of return. However, the simpli ed nature of the model can lead to conclusions which
are net true in general, though true for Walter’s model. The criticisms on the model are as follows:
1. Walter’s model of share valuation mixes dividend policy with investment policy of the rm. The model
assumes that the investment opportunities of the rm are nanced by retained earnings only and no external
nancing debt or equity is used for the purpose when such a situation exists either the rm’s investment or its
dividend policy or both will be sub-optimum. The wealth of the owners will maximise only when this optimum
investment in made.
2. Walter’s model is based on the assumption that r is constant. In fact decreases as more investment
occurs. This re ects the assumption that the most pro table investments are made rst and then the poorer
investments are made. The rm should step at a point where r = k. This is clearly an erroneous policy and fall to
optimize the wealth of the owners.
3. A rm’s cost of capital or discount rate, K, does not remain constant; it changes directly with the rm’s
risk. Thus, the present value of the rm’s income moves inversely with the cost of capital. By assuming that the
discount rate, K is constant, Walter’s model abstracts from the e ect of risk on the value of the rm.
Gordon’s Dividend Theory
The Gordon’s Model, given by Myron Gordon, also supports the doctrine that dividends are relevant to the
share prices of a rm. Here the Dividend Capitaliza on Model is used to study the e ects of dividend policy on a stock
price of the rm. Gordon’s Model assumes that the investors are risk averse i.e. not willing to take risks and prefers
certain returns to uncertain returns. Therefore, they put a premium on a certain return and a discount on the
uncertain returns. The investors prefer current dividends to avoid risk; here the risk is the possibility of not getting
the returns from the investments.
But in case, the company retains the earnings; then the investors can expect a dividend in future. But the
future dividends are uncertain with respect to the amount as well as the time, i.e. how much and when the
dividends will be received. Thus, an investor would discount the future dividends, i.e. puts less importance on it as
compared to the current dividends.
SPONSORED SEARCHES
expected dividend method bcom 6th semester dividend theory
dividend stocks to buy business nancial management
According to the Gordon’s Model, the market value of the share is equal to the present value of future
dividends. It is represented as:
P = [E (1-b)] / Ke-br
Where, P = price of a share
E = Earnings per share
b = retention ratio
1-b = proportion of earnings distributed as dividends
Ke = capitalization rate
Br = growth rate
Assumptions of Gordon’s Model:
1) The rm is an all-equity rm; only the retained earnings are used to nance the investments, no external
source of nancing is used.
2) The rate of return (r) and cost of capital (K) are constant.
3) The life of a rm is inde nite.
4) Retention ratio once decided remains constant.
5) Growth rate is constant (g = br)
6) Cost of Capital is greater than br
Criticism of Gordon’s Model
1) It is assumed that rm’s investment opportunities are nanced only through the retained earnings and
no external nancing viz. Debt or equity is raised. Thus, the investment policy or the dividend policy or both can be
sub-optimal.
2) The Gordon’s Model is only applicable to all equity rms. It is assumed that the rate of returns is
constant, but, however, it decreases with more and more investments.
3) It is assumed that the cost of capital (K) remains constant but, however, it is not realistic in the real life
situations, as it ignores the business risk, which has a direct impact on the rm’s value.
Thus, Gordon model posits that the dividend plays an important role in determining the share price of the
rm.
Retained Earnings or Ploughing Back of Pro t
Retained earnings are internal sources of nance for any company. Actually is not a method of raising
nance, but it is called as accumulation of pro ts by a company for its expansion and diversi cation activities.
Retained earnings are called under di erent names such as self nance; inter nance, and plugging back of pro ts.
As prescribed by the central government, a part (not exceeding 10%) of the net pro ts after tax of a nancial year
have to be compulsorily transferred to reserve by a company before declaring dividends for the year.
Under the retained earnings sources of nance, a reasonable part of the total pro ts is transferred to
various reserves such as general reserve, replacement fund, reserve for repairs and renewals, reserve funds and
secrete reserves, etc.
Retained earnings or pro ts are ploughed back for the following purposes.
1) Purchasing new assets required for betterment, development and expansion of the company.
2) Replacing the old assets which have become obsolete.
3) Meeting the working capital needs of the company.
4) Repayment of the old debts of the company.
Advantages of Retained Earnings
Retained earnings consist of the following important advantages:
1. Useful for expansion and diversi cation: Retained earnings are most useful to expansion and
diversi cation of the business activities.
2. Economical sources of nance: Retained earnings are one of the least costly sources of nance since it
does not involve any oatation cost as in the case of raising of funds by issuing di erent types of securities.
3. No xed obligation: If the companies use equity nance they have to pay dividend and if the companies
use debt nance, they have to pay interest. But if the company uses retained earnings as sources of nance, they
need not pay any xed obligation regarding the payment of dividend or interest.
4. Flexible sources: Retained earnings allow the nancial structure to remain completely exible. The
company need not raise loans for further requirements, if it has retained earnings.
5. Increase the share value: When the company uses the retained earnings as the sources of nance for
their nancial requirements, the cost of capital is very cheaper than the other sources of nance; hence the value
of the share will increase.
6. Avoid excessive tax: Retained earnings provide opportunities for evasion of excessive tax in a company
when it has small number of shareholders.
7. Increase earning capacity: Retained earnings consist of least cost of capital and also it is most suitable to
those companies which go for diversi cation and expansion.
Disadvantages of Retained Earnings
Retained earnings also have certain disadvantages:
1. Misuses: The management by manipulating the value of the shares in the stock market can misuse the
retained earnings.
2. Leads to monopolies: Excessive use of retained earnings leads to monopolistic attitude of the company.
3. Over capitalization: Retained earnings lead to over capitalization, because if the company uses more and
more retained earnings, it leads to insu cient source of nance.
4. Tax evasion: Retained earnings lead to tax evasion. Since, the company reduces tax burden through the
retained earnings.
5. Dissatisfaction: If the company uses retained earnings as sources of nance, the shareholder can’t get
more dividends. So, the shareholder does not like to use the retained earnings as source of nance in all situations.
Calculation of Cost of Retained Earnings
Generally, retained earnings are considered as cost free source of nancing. It is because neither dividend
nor interest is payable on retained pro t. However, this statement is not true. Shareholders of the company that
retains more pro t expect more income in future than the shareholders of the company that pay more dividends
and retains less pro t. Therefore, there is an opportunity cost of retained earnings. In other words, retained
earnings is not a cost free source of nancing. The cost of retained earning must be at least equal to shareholders
rate of return on re-investment of dividend paid by the company.
Determination of Cost of Retained Earning
In the absence of any information relating to addition of cost of re-investment and extra burden of personal
tax, the cost of retained earnings is considered to be equal to the cost of equity. However, the cost of retained
earnings di ers from the cost of equity when there is otation cost to be paid by the shareholders on re-
investment and personal tax rate of shareholders exists.
i) Cost of retained earnings when there is no otation cost and personal tax rate applicable for
shareholders:
Cost of retained earnings (kr) = Cost of equity (ke) = (D1/NP) +g where,
D1= expected dividend per share
NP= current selling price or net proceed
ii) Cost of retained earnings when there is otation cost and personal tax rate applicable for
shareholders:
Cost of retained earnings (kr) = Cost of equity (ke) x 1-fp) (1-tp)
Where,
Fp = otation cost on re-investment (in fraction) by shareholders
Tp = Shareholders' personal tax rate.
Determinants or Factors of Ploughing Back of Pro ts or Retained Earnings
(a) Total Earnings of the Enterprise: The question of saving can arise only when there are su cient pro ts.
So larger the earnings larger the savings, it is a common principle of nancial management.
(b) Taxation Policy of the Government: The report submitted by Taxation Enquiry Commission has brought
into light that taxation policy of the Government tells upon it the taxes are levied at high rates. Hence, it is also an
important determinant of corporate savings.
(c) Dividend Policy: It is policy adapted by the top management (board of directors) in regards to
distribution of pro ts. A conservative dividend policy is essential for having good accumulation of corporate
savings. But, dividend policy is highly in uenced by the income expectation of shareholders and by general
environment prevailing in the country.
(d) Government Attitudes and Control: Govt. is not only a silent spectator but a regulatory body of
economic system of the country. Its policies, control order and regulatory instructions-all compel the organizations
to work in that very direction for example compulsory Deposit Scheme which had been in force.
(e) Other Factors : Other factors a ecting the retained earnings are:
(a) Tradition of industry.
(b) General economic and social environment prevailing in the country.
(c) Managerial attitudes and philosophy, etc.
Dividend Payout Ratio and Optimal Dividend Payout Ratio
The dividend payout ratio measures the percentage of net income that is distributed to shareholders in the
form of dividends during the year. In other words, this ratio shows the portion of pro ts the company decides to
keep to fund operations and the portion of pro ts that is given to its shareholders. Investors are particularly
interested in the dividend payout ratio because they want to know if companies are paying out a reasonable
portion of net income to investors. The dividend payout formula is calculated by dividing total dividend by the net
income of the company i.e.
Dividend Payout Ratio = Total Dividend/Net income
Optimal Dividend Payout Ratio: Dividend payout ratio maximizes the rm’s value. A payout ratio which
maximizes the rm’s value is called optimal dividend payout ratio. A rm achieves this dividend payout-ratio at that
point where it minimises the total cost of nancing. The minimization of sum of total cost of nancing produces a
unique dividend payout ratio for the rm.
Tags # dibrugarh university notes # Financial Management Notes     
About Kumar Nirmal Prasad

Kumar Nirmal Prasad is the founder and CEO of Dynamic tutorials and Services. Dynamic Tutorials
and Services is a Leading Coaching Centre of Tinsukia District. We provide complete coaching for
Commerece and Arts stream from Class 12 to Master Degree level. Also we have statrted coaching
for various competitive exams like RBB, SSC, UGC - NET, State Level Competitive Exams.
Newer Article Older Article

Direct Tax Law - I Notes: Introduction To Income Tax Financial Management Notes: Investment Decisions
RELATED POSTS:
Business Statistics Solved Business Statistics Solved Business Statistics Solved Principles of Marketing Solved
Question Papers: Nov' 2018 Question Papers: Nov' 2017 Question Papers: Nov' 2015 Papers: Nov' 2017 (3rd Semester)
Kumar Nirmal Prasad

Follow me on YouTube - Dynamic Tutorials and Services
Popular Posts for the Day

Auditing Multiple Choice Questions and Answers | Auditing MCQ For CA, CS and CMA Exams | Principle of Auditing MCQs
Corporate Accounting Multiple Choice Questions and Answers for Upcoming Exam | Company Accounts MCQs
MCQ - Business Economics | Managerial Economics Multiple Choice Questions | Business Economics Quiz
MCQ - Single Entry System | Multiple Choice Questions and Answers | Accounting From Incomplete Records | CMA MCQ
MCQ - Branch Accounting | Multiple Choice Questions and Answers | PAPER 5 FINANCIAL ACCOUNTING | CMA MCQ
MCQ - Royalty Accounts | Multiple Choice Questions and Answers | PAPER 5 FINANCIAL ACCOUNTING | CMA MCQ
Ratio Analysis MCQs | Multiple Choice Questions and Answers | Accounting Ratio MCQs
MCQ - Hire Purchase and Instalment Purchase System | Multiple Choice Questions and Answers | PAPER 5 FINANCIAL ACCOUNTING | CMA MCQ
I MP O R TA N T N O T E S I MP O R TA N T L I N KS I MP O R TA N T PAG E S
ACCOUTANCY NOTES AHSEC OFFICIAL WEBSITE Contact Us
COST ACCOUNTING NOTES DIBRUGARH UNIVERSITY OFFICIAL WEBSITE About Us
FINANCIAL MANAGEMENT NOTES GAUHATI UNIVERSITY OFFICIAL WEBSITE Privacy Policy
BUSINESS STATISTICS NOTES IGNOU OFFICIAL WEBSITE Disclaimer
PBM NOTES JOBS IN ASSAM & NE REGION ICAI - CA COURSE
BUSINESS LAWS KKHSOU OFFICIAL WEBSITE ICMAI - CMA COURSE
COMPANY LAWS NOTES NIOS OFFICIAL WEBSITE ICSI - CS COURSE
UGC NET NOTES TINSUKIA COLLEGE OFFICIAL WEBSITE CFA COURSE
Copyright © 2021 Dynamic Tutorials and Services | Designed By Kumar Nirmal Prasad       

Financial Management Notes - Dividend Decision - Dynamic Tutorials and Services

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Financial Management Notes - Dividend Decision - Dynamic Tutorials and Services

Uploaded by

Copyright:

Available Formats

1/26/2021 Financial Management Notes: Dividend Decision - Dynamic Tutorials and Services

OTHER SERVICES AND BLOGS OF DYNAMIC TUTORIALS AND SERVICES

business nancial management dividend companies

Financial Management Notes: Dividend Decision

Unit – IV: Dividend Decisions FEATURED POST AHSEC SOLVED PA

Dividend may be divided into following categories:

2. Stock Dividend or Bonus Dividend.

4. Property Dividend. CMA COURSE DIBRUGARH UNIVER

6. Interim Dividend.  CMA FOUNDATION SOLVED PAPERS

7. Special or Extra Dividend.  CMA FOUNDATION SYLLABUS

8. Optional Dividend.  CMA IMPORTANT TOPICS

Some of these are explained below:  CMA INTERMEDIATE NOTES

Types of Dividend Policy 2 5 2 0 1 0 8 9

a) Constant D/P ratio.

b) Constant dividends per share.

c) Constant dividend per share plus extra dividends.

c) Regular earnings in the form of dividend satisfy investors.

e) This policy is helpful for expansion and growth prospects of a company.

a) Sometime despite of large earnings, management decides not to declare dividends.

c) This policy is used to capitalise reinvested earnings of the rm.

Factors In uencing Dividend Decision

Modigliani and Miller approach (M & M Hypothesis)

b) All information is freely available to all the investors.

c) There is no transaction cost.

e) There are no taxes and no otation cost.

P0= 1* (D1+P1)/ (1+ke)

P0 = Present market price of the share

Ke = Cost of equity share capital

D1 = Expected dividend at the end of year 1

P1 = Expected market price of the share at the end of year 1

dividend stocks to buy business nancial management

a) Payment of dividend by the rm

b) Rising of fresh capital.

a) First, perfect capital market is not a reality.

Walter’s Dividend theory

P = D/k + {r*(E-D)/k}/k, where

P = market price per share

D = dividend per share

E = earnings per share

r = internal rate of return of the rm

k = cost of capital of the rm

a) An in nite ow of dividends, and

b) An in nite ow of gains on investments from retained earnings.

Walter’s model is based on the following assump ons:

c) All earnings are either distributed as dividend or reinvested internally immediately.

assumed to remain constant forever in determining a given value.

e) The rm has a very long or in nite life.

Criticism of Walter’s theory:

Gordon’s Dividend Theory

dividend stocks to buy business nancial management

Where, P = price of a share

E = Earnings per share

1-b = proportion of earnings distributed as dividends

Assumptions of Gordon’s Model:

3) The life of a rm is inde nite.

4) Retention ratio once decided remains constant.

5) Growth rate is constant (g = br)

6) Cost of Capital is greater than br

Criticism of Gordon’s Model

Retained Earnings or Ploughing Back of Pro t

2) Replacing the old assets which have become obsolete.

3) Meeting the working capital needs of the company.

4) Repayment of the old debts of the company.