fm ii sem mba dividend policy

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DIVIDEND DECISION

Vignan Institute of Technology and Aeronutical Engineering ( VITAE)

G.Prabhakar,Dept.of Business Management,

Vignan- Deshmukhi



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)



Different types of dividend :

Cash Dividend

Stock Dividend

Bond Dividend

Property Dividend

Special Dividend




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)



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.




Factors influencing dividend policy :

Age of company

Past dividend rate

Liquidity of funds Stability in earning

Expectations of shareholders Legal restrictions




Types of Dividend Policy :

Conservative Vs liberalRegular Vs Irregular

Stable dividend policy




1.Relevance concept2.Irrelevance concept




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.




W

alter Model :WALTER MODEL Dividendpolicy affects the value of the

firm. Assumptions

Valuation

Optimum Payout Ratio

Criticism




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)



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 !




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

!

!

!

!

! !

! !

! !





Growth Firms Retain allearnings

Normal Firms Distribute allearnings

Declining Firms No effect




No external Financing

Constant Rate of Return

Constant opportunity cost

of capitalVignan Institute of Technology and Aeronutical Engineering ( VITAE)



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)



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)



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 !




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

!

!

!

!

!

!

!





Growth Firms Retain allearnings

Normal Firms Distributeall earnings

Declining Firms No effect




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)



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)



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.




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.




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.




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.




Other Dividends & Dividend Alternatives

Dividends

Cash

Stock

Dividend Equivalents

Stock repurchase

Stock split




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)




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




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%




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




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)



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




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




Financial management I.M. PANDEY

Financial management KHAN & JAIN


fm ii sem mba dividend policy

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