DIVIDEND POLICY PPT.pptx

Dividend Policy 2.pptx

1. DIVIDEND POLICY Features I t is a set of guidelines about payment of dividend. It is decided by the board of directors in the AGM. The dividend decision is taken after taking into account profit available , corporate tax, rate of interest on debentures etc. It can be paid in cash or kind (bonus shares) DIVIDEND CANNOT BE PAID OUT OF CAPITAL.

2. Need of Dividend Decisions To create value for customers To create value for shareholders To generate profitable growth To finance the prospective projects through retained earnings To maintain the interest of existing shareholders. Importance of Dividend Decisions Balance in Growth Value of the Firm Wealth of Shareholders Enhancing Market price Concentration of growth Investors satisfaction Flow of fund Reputation Builds competitive strength.

3. Factors Determining Dividend Policy Internal factors Consistency in earning Stage of the organisation Liquidity Retained earnings Rate of dividend Consistency in dividend payments Rate of expansion Rate of return Cost of financing Degree of control External factors B usiness cycles Government policies Statutory Provisions External Obligations State of Economy

4. TYPES OF DIVIDEND POLICY

5. DIVIDEND DECISION MODELS Walter’s Valuation Model Gordon’s Growth Valuation Model Modigliani & Miller Dividend Irrelevancy Theory

6. WALTER’S VALUATION MODEL Prof. James E Walter proposed a model of share valuation. It supports the view that the dividend policy of the firm has a direct bearing on share valuation. Assumptions The firm is all equity financed. Future investments depends on External sources of funds like new equity or debt is not used. The rate of return on investment is constant. The firm has an infinite life. The firm’s business risk does not change. Thus Investmretained earnings. ent decision is based on dividend decision of the firm.

7. Walter’s Formula to arrive at right dividend decision P = where P = Price per equity share D= Dividend per share E = Earnings per share E-D = Retained earnings per share r= Rate of return on investment k= Cost of capital The above equation has two components + The first component is the present value of an infinite stream of dividends and the second component is the present value of an infinite stream of returns from retained earnings.  

8. Implications of Walter’s Model When the rate of return is greater than the cost of capital the price per share increases as the dividend payment ratio decreases. r › k MPS (up) DPS (down) When the rate of return is equal to the cost of capital, the price per share does not vary with the changes in the dividend payment ratio. r = k When the rate of return is lesser than the cost of capital , the price per share increases as the dividend payment ratio increases. r ‹ k MPS (up) DPS (high)

9. Illustration Dimpi & Co. earns Rs . 6 per share having capitalisation rate of 10% and has a return on investment @ 20%. According to Walter’s model, what should be the price per share at 30% dividend payout ratio? Computation of Market Price P = where P = Price per equity share D= Dividend per share ( 30% of Rs.6 =1.80) E = Earnings per share (Rs.6) E-D = Retained earnings per share ( 6- 1.80= 4.20) r= Rate of return on investment (20%) k= Cost of capital (10%) P = P = = = Rs . 102  

10. GORDON’S MODEL Myran Gordon proposed a model of stock valuation using dividend capitalisation model. Assumptions The firm is an all equity firm. Investments are purely out of retained earnings. The rate of return on firm’s investment is constant. The growth rate is also constant. The cost of capital for the firm remains constant. The firm has a continuous life. Tax does not exist

11. Gordon’s Formula to arrive at the right dividend decision = Where = Price per share at the end of year 0 = Earnings per share at the end of year 1 (1-b) = Fraction of earnings the firm distributes by way of dividends b= Fraction of earnings the firm ploughs back k= Rate of return required by the shareholders r= Rate of return earned on investments made by the firm. br = Growth rate of earnings and dividends.  

12. Implications When the rate of return is higher than the discount rate, the price per share increases as the dividend payment ratio decreases. r > k D- low, P- high When the rate of return is equal to the discount rate, the price per share remains unchanged due to variations in the dividend payment ratio. r = k When the rate of return is less than the discount rate, the price per share increases as the dividend payment ratio increases. r < k D- high, P- high

13. Illustration : Kajol Ltd’s available information is = 15% , E= Rs.30, r = (i) 14% , (ii) 15% and (iii) 16% You are required to calculate market price of a share of the company as per Gordon model if: b= 40%, b) b = 60% and c) b=80% Calculation of Market Price of Kajol Ltd. = When b= 40% (i) r= 14% P r= 15% P = = = = Rs . 200 (iii= = = = Rs . 191.49 (ii) ) r= 16% P = = = = Rs . 209.30  

14. = b) When b= 60% (i) r= 14% P = = = = Rs . 181.82 (ii) r= 15% P = = = = Rs . 200 (iii) r= 16% P = = = = Rs . 222.22 c) When b= 80% ( i) r= 14% P = = = = Rs . 157.89 (ii) r= 15% P = = = = Rs . 200 (iii) r= 16% P = = = = Rs . 272.73  

15. Modigliani & Miller’s Irrelevancy Model (MM MODEL) M & M argued that dividend policy of a firm has no effect on its value of assets. If the company has declared lower rate of dividend, its retained earnings will increase and its net worth also. Dividend policy has no effect on valuation of a firm. Dividend is not relevant for shareholder’s wealth. Assumptions: There is no personal or corporate tax. There is no cost of floatation , transaction cost or brokerage. Dividend policy has no effect on cost of equity. Capital Investment policy is independent of its dividend policy. Investors borrow and lend at the same rate of interest. No buyer or of securities can influence prices. There exists a perfect capital market with free flow of information. Behaviour of investors is rational. They try to increase their income and wealth. All the market participants know investment opportunities and future net income of all the companies.

16. Computation of market price of a share as per MM Model Where, = Prevailing market price of a share = Market price of a share at the end of period one. = Dividend to be received at the end of period one. =Cost of equity capital. The number of shares to be issued to implement the new project is ascertained with the help of the following formula: Where Change in the number of shares outstanding during the period. I = Total investment amount required for capital budget. E = Earnings or Net Income of the firm during the period . n = No. of shares outstanding at the beginning of the period. = Dividend to be received at the end of period one. = Market price of a share at the end of period one.