LINTNER AND MM DIVIDEND

MODELS

Group members:
Serene Ittikunnath M1244
Tushar Kharate M1254
Wasif Parkar M1261
 LINTNER DIVIDEND POLICY
Companies tend to set long-run target dividends-
to-earnings ratios according to the amount of
positive net-present-value (NPV) projects they
have available.

Earnings increases are not always sustainable. As

a result, dividend policy is not changed until
managers can see that new earnings levels are
sustainable.

The theory is based on the assumption that

investor will prefer to receive a certain dividend
payout now rather than leaving the equivalent
 FORMULA
Dc = CREPSc + (1 C) D(c-1)

Dc = Dividend per share for Current Year

C = adjustment rate
R = target payout rate
EPSc = Earnings per share of Year
c(current yr)
D(c-1)= Dividend rate per share for year
c-1(last yr)
ILLUSTRATION
 Modigliani and Miller(MM)
hypothesis
MM maintain that dividend policy has no
effect on the share prices of the firm and
therefore has no consequences.

What matters is the investment policy through

which the firm can increase its earnings and
thereby the value of the firm.

The crux of their argument is that investors

are indifferent between dividend and retained
earnings.
 FORMULA
P0= (D1+ P1)/ (1 + ke)

Where:P0=Prevailing market price of a

share
ke=cost of equity capital
D1=Dividend to be received at the end of
period 1
P1=Market price of a share at the end of
period 1.
 ASSUMPTION
Perfect capital markets in which all in which all
investors are rational. Information is available to
all free of cost; securities are infinitely divisible; no
investor is large enough to influence the market
price of securities; there are no floatation cost.

There are no taxes. Alternatively, there are no

differences in tax rates applicable to capital gains
and dividends.

A firm has a given investment policy which does

not change
 ILLUSTRATION
A company whose capitalization rate is 10% has
outstanding shares of 25,000 selling at Rs.100
each. The firm is expecting to pay a dividend of
Rs.5 per share at the end of the current financial
year.
The company's expected net earnings are
Rs.250,000 and the new proposed investment
requires Rs.500,000.
----------------------------------------------------------------------
------
1) Price of the share at the end of the year if
dividend is not declared.
=> 100 = 0 + p1/ 1+0.10
*Amount required to be raised from the issue of
new shares:
=> 500,000 (250,000 -0) = Rs. 250,000

Number of additional shares to be issued:

=> 250,000/ 110 = 2272.7273 shares

Value of the firm:

=>(25,000 + 2272.7273) (110) - 500,000 +
250,000
(1 + 0.10)
=> 2,500,000
2) Value of the firm when dividend are paid.
*Price per share at the end of the year.
=> 100 = 5 + p1/ 1+0.10
= 105

Amount required to be raised from the issue of

new shares:
=> 500,000 ( 250,000 - 125,000)
=> 375,000

Number of additional shares to be issued:

= 375,000 / 105 => 3571.42857 shares
Value of the firm:
=>(25,000 + 3571.42857) (105) - 500,000 +
250,000
(1 + 0.10)
=> Rs. 2,500,000

Thus, according to MM model, the value of

the firm remains the same whether dividends
are paid or not. This example proves that the
shareholders are indifferent between the
retention of profits and the payment of dividend.
 LIMITATION
The assumptions are unrealistic and untenable in
practice.

As a result the conclusion that dividend payments

and other methods of financing exactly offset each
other and hence, the irrelevance of dividends is
not a practical proposition.

The validity of MM approach is open to question on

two counts. (i) Imperfection of capital market (ii)
Resolution of uncertainty.