Dividend Policy Business Law

8/13/2019 Dividend Policy Business Law

1/25

Dividend Policy

PRESENTED BY:MANMEET SINGH

KAWALPREET KAUR

AMANPREET KAUR

EKTA VERMA


2/25

WHAT IS DIVIDEND?

The term dividend refers to that part of profits

of a company which is distributed by the

company among its shareholders.

It is the reward of the shareholders for

investments made by them in the shares of the

company.


3/25

DIVIDEND POLICY

The dividend policy of a firm determines what

proportion of earnings is paid to shareholders

by way of dividends and what proportion is

ploughed back in the firm for reinvestment

purposes.

The most controversial issue arises is what is

the relationship between dividend policy andmarket price of equity shares.


4/25

Models

In which investment and dividend decision are

related or theory of relevance.

In which investment and dividend decisions

are not related or theory of irrelevance.


5/25


6/25

Theory of relevance

Walter model

Gordon model


7/25

Walters approach

James Walter has proposed the model.

It is based on the relationship between the firms

Return on investment i.e., r

Cost of capital, i.e., k If r>k i.e., if the firm earns a higher rate of return on

its investment than the required rate of return, thefirm should retain the earnings. Such firms aretermed as growth firms and their payout ratio iszero.


8/25

Assumptions

The firm is an all- equity financed entity.

Further it will rely only on retained earnings

to finance its future investments. This means

that the investment decision is dependent on

the dividend decision.

The rate of return on investment is constant.

The firm has an infinite life


9/25

Implications

R>k ,the price per share increases as thedividend payout ratio decreases. The optimumpayout ratio for a growth firm is nil.

R = k, the price per share does not vary withchanges in dividend payout ratio. Theoptimum payout ratio for a normal firm isirrelevant.

R < k, the price per share increases as thedividend payout ratio decreases. The optimumpayout ratio for a firm is 100% .


10/25

Gordon model

Myron Gordon proposed a model of stock

valuation using the dividend capitalizationapproach.


11/25

Assumptions

Retained earnings represent the only source of

financing for the firm.

The rate of return on firm investment is

constant.

The growth rate of the firm is the product of its

retention ratio and its rate of return.


12/25

The firm has a perpetual life.

Tax does not exist.

The cost of capital for the firm remainsconstant and it is greater than the growth rate.


13/25

Implications

R>k ,the price per share increases as thedividend payout ratio decreases. The optimumpayout ratio for a growth firm is nil.

R = k, the price per share does not vary withchanges in dividend payout ratio. Theoptimum payout ratio for a normal firm isirrelevant.

R < k, the price per share increases as thedividend payout ratio decreases. The optimumpayout ratio for a firm is 100% .


14/25

TRADITIONAL THEORY

It is given by Graham and Dodd. Acc to this

approach in the valuation of shares the weight

attached to its dividend is equal to four times

the weight attached to retained earnings.

The major contention of the traditional

position is that a liberal payout policy has a

favorable impact on stock price


15/25


16/25

Criticism

The equation a) is misspecified because it

omits risk which is an important determinant

of price.

The omission of risk imparts an upward bias to

b, the coefficient of dividend and downward

bias to c, the coefficient of retained earnings.


17/25


18/25

Residual approach

This theory assumes that investors do notdifferentiate between dividends and retentions by

the firm. Their basic desire is to earn higher return on their

investment.

In case the firm has profitable investmentopportunities giving a higher rate of return thanthe cost of retained earnings, the investors wouldbe content with the firm retaining the earnings to

finance the same.


19/25

However, if the firm is not in a position to findprofitable investment opportunities, the

investors would prefer to receive the earnings

in the form of dividends. Thus, a firm should retain the earnings if it has

profitable investment opportunities, otherwise

it should pay them as dividends.


20/25

MILLER AND MODIGLIANI

MODEL

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 firmor its investment policy.

The splitting of earnings between retentions

and dividends, may be in any manner the firmlikes, does not effect the value of the firm.


21/25


22/25

Assumptions

Investment opportunities and future profits of

the firm are known with certainty.

There are no taxes.

Floatation costs are nil.

Investment and financing decisions are

independent. Information is freely available to everyone

equally.


23/25

Criticism

Regarding issue cost or floatation cost.

Regarding tax position.

Informational content.

Uncertainty and fluctuations.


24/25

IMPLICATIONS

MM dividend irrelevance theorem.

Exist on their leverage irrelevance theorem.

There is no conflict between dividend

capitalization approach.


25/25

THANKYOU

Date post:	04-Jun-2018
Category:	Documents
Upload:	rohanjangid8
View:	215 times
Download:	0 times

Dividend Policy Business Law

Documents