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8/8/2019 Dividend Policy & Firm Value
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DIVIDEND POLICY
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DIVIDEND POLICYDIVIDEND POLICY
Investment =>Cash flowsInvestment =>Cash flows
Financing=>BorrowalFinancing=>Borrowal
Retention Rate=>Growth rateRetention Rate=>Growth rate
DividendDividend
Buy backBuy back
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SHARE BUYBACKS
Share buybacks,referred to asequityrepurchases orstockrepurchases in the
US,have becomepossiblesince 1998 inIndia.
In India,corporates generally choose theopen market purchase method. Under
this method,acompany buys sharesfrom thesecondary market overaperiodofone yearsubject to a maximum pricefixed by the board/shareholders.
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RATIONALE FOR BUYBACKS
Efficient allocation of resources (Give excess cash
back)
Rationalize capital structure. (Control)
Price stability
Tax advantage
No implied commitment
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OBJECTIONS TO BUYBACKS
Unfair advantage
Manipulation
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REGULATION OF BUYBACKS.
A company can buyback 10 percent of its shares annually with
board resolution. Beyond that a special resolution of
shareholders is required.
The post-buyback debt-equity ratio should not exceed 2:1
The buyback should not exceed 25 percent of the total paid up
capital and free reserves.
After completing a buyback programme, a company should not
make a further issue of equity securities within a period of 6
months, except in certain cases.
A buyback cannot be done through negotiated deals.
The buyback process has to be handled by a merchant bankers
duly appointed by the company.
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BuybackBuyback
E.g PAT = Rs.1 Crore EPS = Rs.10E.g PAT = Rs.1 Crore EPS = Rs.10
No: of shares(pre buy back) = 10 lakhsNo: of shares(pre buy back) = 10 lakhs
The Co. decides to repurchase 200000The Co. decides to repurchase 200000shares at Rs.180.P/E ratio stays at 20.shares at Rs.180.P/E ratio stays at 20.
New EPS = 100,00,000/8,00,000 = 12.5New EPS = 100,00,000/8,00,000 = 12.5
New Price = 12.5 * 20 = 250New Price = 12.5 * 20 = 250
Tendering does not make sense.Tendering does not make sense.
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DIVIDEND POLICYDIVIDEND POLICY
Dividends are stickyDividends are sticky
Dividends tend to follow earningsDividends tend to follow earnings
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DIVIDEND POLICYDIVIDEND POLICY
Pay out ratioPay out ratio
Dividend YieldDividend Yield
Rationale for payout ratio > 100% ?Rationale for payout ratio > 100% ?
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Under leveragedUnder leveraged
New DebtNew Debt
Cyclical firmsCyclical firms
Recession & BoomRecession & Boom
Firms in the declining growthFirms in the declining growth
Cash SurplusCash Surplus
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DIVIDEND POLICY : PAYOUT RATIO
The considerations relevant for determining the dividend
payout ratio are:
Funds requirement
Liquidity
Access to external sources of financing
Shareholder preferences
Difference in the cost of external equity and retainedearnings
Control
Taxes
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SCHOOLS OF THOUGHTSCHOOLS OF THOUGHT
IrrelevantIrrelevant-- Dividends does not matterDividends does not matter
Tax preferenceTax preference-- Dividends are badDividends are bad
BirdBird--inin--thethe--handhand-- Dividends are goodDividends are good
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DIVIDEND POLICIES IN PRACTICE
Generous dividend and bonus policy
More or less fixed dividend policy
Erratic dividend policy
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Electrical: Try to maintain a 10%, which isElectrical: Try to maintain a 10%, which is
required by the govt.required by the govt.
Tea: In the last 10 years, theTea: In the last 10 years, the
Parent company has not been insisting onParent company has not been insisting on
any dividend. Whatever has been paid outany dividend. Whatever has been paid out
has been accepted. Our payout has been 30has been accepted. Our payout has been 30
to 50%.to 50%.
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Chemical: Our dividend policy is to pay aChemical: Our dividend policy is to pay a
fixed rate of dividend and issue bonusfixed rate of dividend and issue bonus
shares when we are eligible. The purpose isshares when we are eligible. The purpose isto ensure that shareholders retain sharesto ensure that shareholders retain shares
to enjoy capital gains.to enjoy capital gains.
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Leasing: We would like to declare as highLeasing: We would like to declare as high
dividends as we can. If share prices rise duedividends as we can. If share prices rise due
to that we can raise relatively easily moreto that we can raise relatively easily morefunds by issuing convertible debentures.funds by issuing convertible debentures.
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Diversified: We have a very conservativeDiversified: We have a very conservative
dividend policy. Our dividend rate whichdividend policy. Our dividend rate which
used to be 10% four years ago has nowused to be 10% four years ago has nowbeen raised to 15%. We wont probablybeen raised to 15%. We wont probably
consider a change for the next few years.consider a change for the next few years.
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GUIDELINES FORDIVIDEND POLICY
Dont pay dividends at the expense of positive NPV projects.
Minimise the need to sell external equity.
Define a target dividend payout ratio along with a target
debt-equity ratio, taking into account the investment needs,
managerial preferences, capital market norms, and tax code.
Accept temporary departures from the target dividend payout
ratio and the target debt-equity ratio.
Avoid dividend cuts.
In essence, the above guidelines imply that a firm should pursue a
smoothed residual dividend policy and not a pure residual
dividend policy or a fixed dividend payout policy.
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BONUS SHARES
A bonus issue represents capitalisation of free reservesbuilt out of the genuine profits or share premium
collected in cash only
In the wake of a bonus issue:
(a) The shareholders proportional ownership remains
unchanged.
(a) The book value per share, the earnings per share,
and the market price per share decrease, but the
number of shares increases.
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Bonus IssueBonus Issue Stock Split Stock Split
The par value of the share isThe par value of the share isUnchangedUnchanged
The par value of the share isThe par value of the share isReducedReduced
A part of reserves isA part of reserves is
capitalisedcapitalised
There is no capitalisation ofThere is no capitalisation of
reservesreserves
The shareholdersThe shareholdersproportional ownershipproportional ownership
remains unchangedremains unchanged
The shareholders proportionalThe shareholders proportionalownership remains unchangedownership remains unchanged
TheThe bookbook valuevalue perper share,share, thetheearningsearnings perper share,share, andand thethe
marketmarket priceprice perper shareshare declinedecline
The book value per share, theThe book value per share, theearnings per share, and theearnings per share, and themarket price per share declinemarket price per share decline
The market price per share isThe market price per share isbrought within a popularbrought within a populartrading range.trading range.
The market price per share isThe market price per share isbrought within a more popularbrought within a more populartrading range.trading range.