INTRODUCTION

The term dividend refers to that parts of profit of a

company which is distributed by the company among
its shareholders .It is the reward of the shareholders for
investment made by them in the shares of a company.
The investors are interested in earning the maximum
return on their investments and to maximize their
wealth.
DIVIDEND DECISION
The value of the firm can be maximised if the
shareholders wealth is maximized.
According to one school of thought dividend decision
does not affect the shareholders wealth and hence the
valuation of the firm.
On the other hand, according to other school of
thought, dividend decisions affects the shareholders
wealth and also the valuation of the firm .
TWO SCHOOLS OF THOUGHTS
IRRELEVANCE CONCEPT RELEVANCE CONCEPT
1. RESIDUAL APPROACH 1. WALTER ‘S APPROACH
2. MODIGLIANI AND MILLER 2. GORDON’S APPROACH
APPROACH
RESIDUAL APPROACH
According to this theory, dividend decision has no effect
on the wealth of the shareholders or the price of the
shares, and hence it is irrelevant so far as the valuation
of the firm is concerned. This theory regards dividend
decision merely as a part of financing decision because
the earning may be retained in the business for re
investment. Thus a firm should retain the earnings if it
has profitable investment opportunities otherwise it
should pay them as dividend.
MM MODEL
Modigliani and Miller have expressed in the most
comprehensive manner in support of the theory of ir-
relevance. They maintain the dividend policy has no
effect on the market price of the shares and the
value of the firm is determined by the earning
capacity of the firm or its investment policy.
ASSUMPTION
 1. There are perfect capital markets.
 2. investors behave rationally.
 3. Information about the company is available to all
without any cost.
 4. There are no transaction costs.
 5.No investor is large enough to effect the market price of
shares .
 6. There are either no taxes or there are no differences in
the tax rates .
 7. The firm has a rigid investment policy .
 8.There is no risk or uncertainty in regards to the future of
the firm.
CRITICISM OF MM APPROACH

Perfect capital market does not exist in reality.

Information about the company is not available to all
the persons.
The firm have to incur cost of issuing securities.
The firm do not follow a rigid investment policy.
Shareholder may prefer current income as compared
to future gains.
 RELEVANCE CONCEPT/WALTER
APPROACH
Prof. walter support that dividend decisions are relevant
and affect the value of the firm.
If the firm earn a higher rate of return on its investment then
the required rate of return, the firm should retain the
earning. Such firm in the term of growth firm. This would
maximize the value of shares.
In case the decline firm which do not have profitable
investment, then the firm has distribute its earning.
In case normal firm, where the return
on its investment and the cost of
capital is equal, the dividend policy
will not affect the market value of
shares.
ASSUMPTIONS OF WALTER’S
MODEL

 The investment of firm are financed through retained

earnings only and the firm does not use external
source of fund.
 The internal rate of return and the cost of capital of
the firm are constant.
 Earning and dividends do not change while
determining the value.
 The firm has a very long life.
CRITICISM OF WALTER’S MODEL
 Firm has raised fund by external financing.
 Internal rate of return does not remain constant, with
increase investment the rate of return always change.
 The cost of capital does not remain constant.
Value of a Share

D
P
Ke  g
P= Price of Equity Shares
D= Initial Dividend Per Share
Ke= Cost of equity Capital
g= Expected Growth rate of earnings/Dividend
Market Price of a Share

r ( E  D)
D
P Ke
Ke
P= Market Price Per share
D= Dividend Per Share
r= Internal rate of return
E= Earning Per Share
Ke= Cost of equity capital
GORDEN’S APPROACH
 Prof. Gorden model has been based on the following
assumption.
ASSUMPTION:
 The firm is an all equity firm.
 No external financing is used.
 The rate of return on the investment is constant.
 The cost of capital for the firm remain constant.
 The firm has perpetual life.
 Corporate taxes do not exist.
Market Price of a Share

E (1  b)
P
Ke  br
 P= Price of Share
 E= Earning Per Share
 b= Retention Ratio
 Ke= Cost of equity capital
 br= g= Growth rate in return
Implications of Gordon's Model in
Summarised form:
1.r>k , retain the profits

2.r<k distribute the profits

3. r=k depend on the situation

Here, r= reture, k= cost of capital

DETERMINANTS OF DIVIDEND
POLICY
Legal restrictions
Magnitude and trend
Desire and type of shareholders
Nature of industry
Age of the company
Future financial requirements
Government ‘s economics policy
Taxation policy
Inflation
DETERMINANTS OF DIVIDEND
POLICY
Control objectives
Required of institutional investors
Stability of dividend
Liquid resources
TYPES OF DIVIDEND POLICY
A. REGULAR DIVIDEND POLICY: Payment of
dividend at the usual rate is termed as regular
dividend. The investors such as retired persons
,widows and other economically weaker persons
prefer to get regular dividend.
ADVANTAGES:
 It establishes a profitable record of the company.
 It create confident among the shareholder.
 It stabilised the market value of shares.
STABLE DIVIDEND POLICY
 CONSTANT DIVIDEND PER SHARE: Some companies
follow a policy of paying fixed dividend per share Such firm
create a reserve for dividend equalisation to enable them
pay the fixed dividend in the year when the earning are not
sufficient or when there are losses.
 CONSTANT PAY OUT RATIO: Constant pay out ratio
means payment of a fixed percentage of net earning as
dividend every year.
 STABLE RUPEE DIVIDEND PLUS EXTRA DIVIDEND:
Some companies follow a policy of paying constant low
dividend per share plus an extra dividend in the years of
high profit.
IRREGULAR DIVIDEND POLICY
Some companies follow dividend policy:
 Uncertainty of earning
 Unsuccessful business operations
 Lack of liquid resources
 Fear of adverse effect of regular dividend policy.
NO DIVIDEND POLICY
 A company may follow a policy of paying no dividend
presently because of its unfavourable working capital
position or required of fund for future expansion and
growth.
FORMS OF DIVIDEND
 CASH DIVIDEND
 SCRIP OR BOND DIVIDEND
 PROPERTY DIVIDEND
 STOCK DIVIDEND
 BONUS ISSUE
A company pay bonus to its shareholders either in cash
or in the form of shares. Many a times a company is
not in the position to pay bonus in cash inspite of
sufficient profit because the unsatisfactory cash
position. In such cases , if the company so desires and
the article of the association of the company provide, it
can pay bonus to its shareholders in the form of shares
by the issue of fully paid bonus share.
GUIDELINES FOR THE ISSUE OF
BONUS ISSUE
 CONDITIONS FOR BONUS ISSUE:
It is authorised by the article of association.
In case not authorised then the pass a
resoluation at the general body meeting.
It has sufficient reasons to believe that it has
defaulted in payment.
SOURCE OF DECLARED DIVIDEND
A. OUT OF CURRENT PROFIT: Dividend can be
declared by a company out of profit for the current year.
B. OUT OF PAST PROFIT: Dividend can also
be declared out of the undistributed of the
company for any previous financial year.
C. OUT OF MONEY PROVIDE BY THE
GOVERNMENT: A company may also
declared dividend out of the money provide
by the central government for the payment
of dividend in pursuance by the government
.
RIGHT ISSUE
Right issue is an invitation to the existing shareholders
to subscribe for further shares to be issued by a
company. The following conditions must be followed:
 Such shares must be offered to holder of equity shares.
 The offer must be made by giving a notice specifying
the number of shares offered.
 The period of accept the shares within 15 days which is
specified in the notice.
ADVANTAGES OF RIGHT ISSUE
 It ensure that equitable distribution of shares.
 The share are sold only to existing shareholders.
 It create a better image of the company in an
shareholders.
 It ensure that the shareholders do not misuse the
opportunities of issuing share at lower prices.
Valuation of Rights
V= M-S
N+1

V= Value of the right

M= MArket Price of Shares
S= Price offered for right shares
N= Represents the no. of shares to get one right share.
 Question
A Public Ltd. Company offers to its existings shareholders
the right to buy one share at the rate of Rs. 12 per share for
every four shares of Rs. 10 each held in the company. the
market value of the shares on the date of such offer is Rs. 24
per share. Calculate the value of the rights.
V= M-S
N+1

V= 24-12 = 12
4+1 5

= Rs. 2.4
 Question
A Company offers to its shareholders the right to buy 2
share at the rate of Rs. 130 per share for every 5 shares of Rs.
100 each held in the company. the market value of the
shares on the date of such offer is Rs. 200 per share.
Calculate the value of the rights.
 Question
A Company offers to its shareholders the right to buy 2 share at the
rate of Rs. 130 per share for every 5 shares of Rs. 100 each held in the
company. the market value of the shares on the date of such offer is
Rs. 200 per share. Calculate the value of the rights.
Solution:
V= 2oo-130 = 70
5/2+1 3.5

= Rs. 20
THANK YOU