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DIVIDEND DECISION
Vignan Institute of Technology and Aeronutical Engineering ( VITAE)
G.Prabhakar,Dept.of Business Management,
Vignan- Deshmukhi
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Meaning: Meaning The term dividend refer to
that part of divisible profits among itsshareholders. In other words,
dividend is that portion of companysprofit which is distributed among itsshareholders as a percentage of parvalue of share or at a fixed rate pershare according to the decision of its
board of directors.Vignan Institute of Technology and Aeronutical Engineering ( VITAE)
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Different types of dividend :
Cash Dividend
Stock Dividend
Bond Dividend
Property Dividend
Special Dividend
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Dividend Policy :
Dividend Policy Dividend policy is a
very significant financial decision . It
determines the divisions of earnings
between payments to shareholdersand retained earnings. If the value of
firm is a function of its dividend-pay-
out ratio , the dividend policy willaffect directly the firms cost of
capital.Vignan Institute of Technology and Aeronutical Engineering ( VITAE)
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Meaning Dividend policy is a flexible andwide meaning word. This word is
constituted with two words, dividend andpolicy. Dividend is that portion of profits of company which is distributed among its
shareholders whereas policy means plan of action. Thus , the term dividend policy
refers to the policy concerning quantum of
profits to be distributed as dividend.
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Factors influencing dividend policy :
Age of company
Past dividend rate
Liquidity of funds Stability in earning
Expectations of shareholders Legal restrictions
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Types of Dividend Policy :
Conservative Vs liberalRegular Vs Irregular
Stable dividend policy
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1.Relevance concept2.Irrelevance concept
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Relevance Theory : Dividend policy is very essential for
any business firm as it affects theoverall value of the firm. Dividend
policy is relevant & dividend decisionform a very integral part of theinvestment & financing decision of the firm. Shareholders prefer currentdividends & hence there is a directrelationships between the dividendpolicy & the market value of the firm.
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W
alter Model :WALTER MODEL Dividendpolicy affects the value of the
firm. Assumptions
Valuation
Optimum Payout Ratio
Criticism
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Walter Model - assumptions :
The firm finances all investment
through retained earnings while debt
and new equity is not used(InternalFinancing).
Business risk remains constant i.e.,
Constant EPS and DIV. The firm has infinite life.
The firm either goes for a 100% pay-
out or a 100% retention.Vignan Institute of Technology and Aeronutical Engineering ( VITAE)
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Market price per share is the sum of
the present value of the infinite
stream of constant dividends andpresent value of the infinite stream of
capital gains.
( / )(DIV/ ) (EPS ± DIV)
r k P k
k !
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Example0 .15 , 0 .10 , 0.08
0 .10
E P S R s 1 0
D P S 4 0%
(0 .15 / 0 .1)( 4 / 0 .1) (1 0 4 ) R s 1 3 0
0 .1
(0 .10 / 0 .1)( 4 / 0 .1) (1 0 4 ) R s 1 0 00 .1
(0 .08 / 0 .1)( 4 / 0 .1) (1 0 4 ) R s 8 8
0 .1
r
k
P
P
P
!
!
!
!
! !
! !
! !
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Optimum Payout Ratio
Growth Firms Retain allearnings
Normal Firms Distribute allearnings
Declining Firms No effect
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No external Financing
Constant Rate of Return
Constant opportunity cost
of capitalVignan Institute of Technology and Aeronutical Engineering ( VITAE)
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Gordons Model :
GORDONS MODEL Dividendpolicy is relevant to the value of the company.
Assumptions
Valuation Optimum Payout Ratio
CriticismVignan Institute of Technology and Aeronutical Engineering ( VITAE)
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Assumptions All Equity Firm
No External Financing
Constant Return andCost of Capital
Perpetual Earnings
No Taxes
Constant Retention Cost of Capital greater than Growth
RateVignan Institute of Technology and Aeronutical Engineering ( VITAE)
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Market value of a share is equal to the
present value of an infinite stream of dividends to be received byshareholders
EPS(1 ) /( )P b k br !
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Example 0.15, 0.10, 0.08
0.10
EPS s 1060
(1 ± 0.6) / 0.10 ± (0.15 * 0.6) = s 400
10(1 ± 6) / 0.10 ± (0.10 * 0.6) = s 100
10(1 ± 0.6) / 0.10 ± (0.08 * 0.6) = s 77
r
k
b
!
!
!
!
!
!
!
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Optimum Payout Ratio
Growth Firms Retain allearnings
Normal Firms Distributeall earnings
Declining Firms No effect
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The Bird In The Hand
Argument put forward, first of all, byKirshman
Investors are risk averters. Theyconsider distant dividends as less
certain than near dividends. Rate atwhich an investor discounts his dividendstream from a given firm increases withthe futurity of dividend stream and
hence lowering share prices.Vignan Institute of Technology and Aeronutical Engineering ( VITAE)
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Irrelevance Theory : IRRELEVANCE THEORY Dividend
policy is irrelevant to maximizing the
shareholders wealth. Value of the firmis affected by the earning capacity of
the firm i.e., the investment policy
and not the dividend policy.Whetherthe firm retains its earnings or pays
dividend, the market price of the
share is indifferent towards it.Vignan Institute of Technology and Aeronutical Engineering ( VITAE)
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Modigliani & Miller Model :
MODIGILANI & MILLER MODEL The
value of the firm is not affected by the
decision of pay-out or plough-back..Firms dividend policy have no
influence on the market price of the
shares. Modigliani and Miller weretwo staunch supporters of the
irrelevance concept.
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M-M Model -- assumptions :
Perfect capital market.
There are no taxes.
Investment policy is fixed.
No flotation cost on issue of
shares. Investors behave rationally.
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M-M Model - concept :
M-M MODEL - conceptCrux of MMposition is arbitrage argument. Arbitrage isentering simultaneously in twotransactions which balance each other.Between dividend and retention of earnings the investors would be indifferent
due to balancing nature of internalfinancing and external financing. So, thefirm is indifferent towards the dividenddecision.
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M-M Model -- criticisms :
It is wrong to assume that
there are no taxes, flotationcosts do not exist and there isabsence of transaction costs.
There is perfect capital marketcondition is not always true.
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Other Dividends & Dividend Alternatives
Dividends
Cash
Stock
Dividend Equivalents
Stock repurchase
Stock split
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Stock Dividend Stock DividendStock Dividend -- A payment of additional
shares of stock to shareholders. Often used
in place of or in addition to a cash dividend
Payment of additional shares of stock
50% stock dividend would give you 1 extra
share for every 2 you already own
� You own 100 shares @ Rs 12 each (Rs 1200)
� After the stock dividend you have 150 shares atRs 8 (RS 1200)
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Stock Split
Change in number of shares
outstanding
3 for 2 split
� You owned 100 shares at Rs 12 each (Rs
1200)
� After the split you have 150 at Rs 8each (Rs 1200)
Same impact as a stock dividend
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Equivalence of Splits and Stock
Dividends
SPLIT STOCK DIVIDEND
2:1 (2/1)-1 = 100%
3:2 (3/2)-1 = 50%
5:4 (5/4)-1 = 25%
11:10 (11/10)-1 = 10%
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Stock Repurchase
Firm uses excess cash to buy stock back fromexisting shareholders
Substitute for a cash dividend Drives up stock price (capital gain)
Increases firm leverage (less equity after repo)
� Method of altering firms capital structure
Considered by some to be a cheaper form of dividend payment
Used also to avoid hostile takeovers
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Rights issue
An offer of additional shares to existing
shareholders, in proportion to theirholdings, to raise money for the company.
Unlike a bonus issue, a rights issue is notfree. The shareholder is not obliged to takeup a rights issue - the offer can be allowed
to lapse - but rights issues arerenounceable, which means the
shareholder can sell or transfer his or her
right to the shares.Vignan Institute of Technology and Aeronutical Engineering ( VITAE)
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Bonus share issues
Where a company has accumulated
reserves, it may distribute these to
existing shareholders by making abonus issue of additional shares
As with dividends, there will be a
downward adjustment in share pricewhen shares go ex-bonus
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Bonus share issues (cont.)
As no new capital is raised, there is no changein the assets or expected earnings of thecompany
� Exampleif a bonus 1:4 issue is madeCum-bonus price Rs5.00
Market value of 4 cum-bonus shares 20.00
Theoretical value of 5 ex-bonus shares 20.00
Theoretical value of 1 ex-bonus share 4.00
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Financial management I.M. PANDEY
Financial management KHAN & JAIN
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