Dividend policy Decision

Financial Management / Financial Activities are concern with investment decision, Financing
decision and Asset Management decision with some over-goal in mind.
Goal is maximization of share equity. Agency theory involve here,
Dividend policy, what is policy. Policy is the kind of planning, what is dividend, Dividend is
amount from Earning/profit to share a portion for shareholders.
Dividend policy is the long term planning related to payment for the shareholders.
Like Exp, A company decided to pay its shareholder every three years a profit from a every
share par value. This is the policy for dividend.
Another Exp: like a company decided to pay 1 Rs dividend from 100Rs par share per share this
year, and also pay 10% from par value next 4 years This is also the Dividend policy but long
term policy.
Is Dividend policy related to shareholder wealth maximization, if impact negative or positive.
Decision 1)Financing Decision and 2)Investment Decision Also 3)Asset Management Decision

 Dividend policy means taking the Financing from shareholders/ Retain earning.
 Being a agent to the shareholder management is the responsible to earn at-least and
more then the rate of return that get shareholder from market. More profit from
market. Bet the market return. Investment decision.
 Long term investment should sustain growth continue is the Asset management
decision.

- Big Question to Answer weather payment of dividend effects the Market Value of Firm (MSHW)
Maximization of share holder wealth.

- Variables to answer this question 1. SHW (Dependent Variable) 2. Dividend Policy or payment
(Independent Variable).

- Proxy of both Variables

o SHW- (Market Value of Firm or Market Value per Share or MPS * No. of Shares or Market
Value of Total Assets or Sum of Market Value of Debt & Equity)
 To generate it, shareholders will be interested in Dividend & Capital Gain
o Dividend Policy (Kind of Dividends and Kinds of Dividend Measurement)
 Kinds of Dividend (Explicit Dividend or Act as dividend or Implicit Dividend) jo dividend ke
shape pe diya ja rahe he (Explicit Dividend) or kohe hasa decision le rahe he jis ke waja se
decision jaisa kam ho raha he(Implicit Dividend)

  Cash Dividend (Ex-Dividend & Cum Dividend, Tax Deducted Dividend) Cash ke shape pe
hota he, cheque shareholder ko bajh diya jyta he.

 Stock Dividend or Bonus Shares (Large or Small)e New and izafae share ause share
holder ko diye jyte he, exp 1000 share te 10% dividend is saal mile rahe he to mujhe
mare share 1100 hojyenge.

 Stock Split & Reverse Stock Split company split kiye huwe share ko arrange kar ke de
diye he like exp 5 each he ak to 2 mile kar 10 rupees
 Repurchase of Stock (Treasury Stock)
 Liquidation Net Proceeds Value

 Kinds of Dividend Measurement

 Absolute Dividend (In Amount) – Dividend Per Share or Total Dividend Amount

 Dividend Ratio = Dividend per Share / Par Value per share

Dividend policy just depend on amount next 10 years 10 rupees per share dividend we
provide. Next 5 years our dividend 5% grow. We can also calculate if dividend per share not
available Dividend Ratio= Total Dividend/ Total value/total common stock.

 Dividend Payout = Dividend Per Share / Earning Per Share

Total Dividend/ Total earning

 Dividend Yield = Dividend Per Share / Market Price Per Share

 EPS = Earnings Available to Common Stock Holders / No. of Common Shares Outstanding

Dividend policy announce in different ways, if we have historical data we can convert that
policy in measurement shape. We use one trade for 10 years like dividend payout ratio, and
EPS one measurement tool we use. Its shows increasing trend, either decreasing trend.

Clash of Interest (Agency Dispute & learning) – Arguments

Special interest mgt work for shareholder interest, sometime mgt not provide dividend but shareholder
expected dividend that year.

- Interest of Shares holder is Dividend and Interest of Management is Retention (if Necessary)
The growth of the company definitely gives higher benefits into the shareholder means of Necessary
Explicitely shareholder believer dividend should provide but mgt not provide.
Shareholder get return in market 10% if dividend paid, mgt feel from retain earning they invest in market
shareholder get 12% next year from company project.
 Techical terms, if shareholder ownself invent dividend amount in market (Active investment/Active
dividened policy)
If mgt of company invest shareholder amount in the market (Passive investment/passive dividend policy)
Passive policy lease towards the growth of the company, and active policy lease towards the slow growth
of the and maybe no growth.
- Shares holders see his current benefit but Management looks for growth of company
- Dividend received be Invested directly or Indirectly by Shares holders (Understanding of Passive &
Active Dividend Policy) another Key Term Passive Residual Investment Dividend Policy

Residual policy/investment means that after investment from retain earning firm have surplus then again
that surplus provide to shareholders exp 120,000 retain earning firm needed to invest 100,000 remaining
20,000 paid in the dividend.

Either income distributed as Dividend or retained it

- If income distributed 100%, there will be Slow or no growth (Active Policy)

- If income 100% retained, there will be no attraction in company’s shares (100% Passive Policy)

There should be a balance

Short run invertor are not attract from potion b 100% passive policy, they needed dividend profit

T+1 Short seller buy share collect dividend and sell the share next day.

Dividend Pricing models.

Walter’s Model its use for share valuation , what should be the normative price of the share.

Total market value of the firm/ total market value of the assets/share holder wealth, by calculating one share
market value*no of shares we get total market value of the equity.

This model use for share valuation, what should be or what to be the normative price of the shares

- Assumption of Walter’s
 See only Retained Earning as financing decision
 Market rate of Return & Cost of Equity will remain same in future (Business Risk will not change & its Predictable)
Suppose market rate of return is constant, MRR means company get return from retain earning. Cost of equity
company paid dividend, we take decision how much we take and how much we paid. As usually business risk
remain constant means risk invoice for cost of equity like we calculate from CAPM. We assume market risk
premium and beta will not change.
 Growth rate cannot be predicted
First and second three years growth rate not predicted by companies in this assumption.
Know we calculate price.

D/ks is the perpetuity formula, from perpetuity we calculate present value of future
dividend. Ais dividend pe ye cost hamare par rahe he.
P=D/KS P=10/10% P=100 100 rupees is the value of that share that paid 10 rupees
dividend. And this will continue infinite value. 10 rupees divided each years.
(r*(E-D)/ks)/ks But we use retain earning as a financing, when we sue RE as a financing
definitely growth will come. What is the RE amount, how much return we get, how get
discount from RE, how calculate total discount from RE.
 E – D = Retained Earnings Per share = 25 – 10 = 15 ER amount source of financing
From per share we get 15 rupees financing, if we invest these 15 rupees then we get
return.
 P = 100 + {2.25/ Ks } / Ks 15% IRR RE rs 15= 2.25 we get from per share earning from
investing RE every year.

 P = D / Ks + {r*(E-D)/Ks}/Ks where
 P = 10 / 10% + {r*(25 - 10) / Ks}/ Ks
 P = 100 + {15% * (25 - 10)/ Ks}/ Ks
 P = 100 + {2.25/ Ks } / Ks

 P = 100 + {2.25/10%} / Ks
 P = 100 + {22.5} / 10%
 P = 100 + 225 = 325
 P = Market price per share
 D = Dividend per share = 10
 E = Earnings per share = 25
 E – D = Retained Earnings Per share = 25 – 10 = 15 ER amount source of financing
 r = Internal rate of return of the firm = 15% firm get return
 k = Cost of Equity = 10% KS means cost of equity
Gorden Growth

- Assumption of Gorden Growth

 1st Two assumption of Walter’s Model are same
 Growth rate can be predicted
Both assumption are walter’s assumptions, one RE investment, second MRR and Ks long run same.
 Ks is always greater than g
Growth rate can be predict
 Growth rate can be calculated as (Retention ratio * Market rate of Return)
50% Shareholders profit amount companies always in hold.
50% * 10% = 5%
5% Growth/accumulation/hazafa
 Model can only be applicable is there is dividend otherwise it will not work.

P = D1 / (Ks – g)
P = 10 / (10% - 5%) = 200

g = b * Rm, “b represents Retention Ratio & Rm represents Market Rate of Return”

Application of Models on Market Value per Share to See the effect of Dividend

Common Trends

 If Rm is greater than Ks, No dividend (Trend of Price will be declining)

 If Rm is less than ks, No retention (Trend of Price will be increasing)
 If Rm is equal to ks, indifference position (Trend of Price will be same)
 Proxy of Market value of firm is Market price per share
Payout: 40% out of the earning

Data to prove relevancy & irrelevancy

Prices Calculate with different combination of Rm and Payout

8% 10%
8% 8% 10% 10% 15% 15% 15%
Given values in question & &
& & & & & & &
100 100
40% 80% 40% 80% 40% 80% 100%
% %
EPS Rs. 10 Walter’s Dividend Valuation (Pricing) Model
Ks 10% 88 96 100 100 100 100 130 110 100
Rm 8% or 10% or 15% Gorden Growth Dividend Valuation (Pricing) Model
Payout 40% or 80% or 100% 77 95 100 100 100 100 400 114 100
Relevancy Irrelevancy Relevancy

This formula will give you a clear position of Dividend Policy, if Rm is equal to Ks then what ever will be
Dividend the value of share will be same. This is an example of Irrelevance Policy.
Imbalance only created where Rm will not be equal to Ks, this required to be address with respect to
irrelevancy & relevancy.

At he point of irrelevancy, we increase dividend but not impact on market price of share in both model. This is
called dividend payout is irrelevant to the value of common stock. Cost of capital/ cost of equity and rate of
return same Ks=IRR then no impact of the change of dividend policy and payout share value no impact. If its
permentant phenomena then diffienctly not impact irreveant to the share price. If temporary phenome
change due to other factor come.

Comprehensive Case of Dividend Policy:

X Company Started Business on 1st January 2019, Company issued 20,000 Ordinary Shares at Par Rs. 100
right at start. At the end of December 31 st 2019, the Company reported Rs. 1,000,000 Profit after Tax.
Company is planning for the year 2020. On January 01, 2020, the Market Quoted Share price at Rs. 100
and Company is expecting to pay dividend at rate of 20%. Currently Company facing opportunity cost of
equity 12%. In the Year 2020, Company is willing to start a new project with Rs. 2,000,000 that can
provide 15% rate of return. Read the solve the following situations assume no tax world except where it
is mentioned.

 Calculate after 10% tax dividend, Identify Cum Cash Dividend Price & Calculate Ex-Cash Dividend Price
for 2020. Dividend after tax = Dividend Amount – Tax on dividend = Dividend * (1 – Tax%)
Dividend after tax = (100 * 20%) – (100 * 20% * 10%) = Rs. 18 or
Dividend after tax = (100 * 20%) * (1 – 10%) = Rs. 18
Cum dividend Price = Ex Dividend Price + After tax Dividend
100 = Ex-Dividend Price + 18
Ex-Dividend Price = 100 – 18 = 82

Cum dividend means eligibility date for dividend.

Thursday January 15 Wednesday January 28 Friday January 30 Monday February 16 days

Declaration date Ex-Dividend date Record date Payment date

1)Declaration date: The board of directors declares a payment of dividends.

2)Ex-Dividend: A share of stock goes ex-dividend on the date the seller is entitled to keep the dividend:
shares are traded ex-dividend on the after the second business day before the record date.
3)Record date: The declared dividends are distributable to people who are shareholders of record as of
this specific date. T+2 rules.

4)Payment date: The dividend checks are mailed to shareholders of record.

 Show impact of 20% & 40% Stock Dividend or Bonus Shares on all Contents of Shares Holders Equity
of 2019. Assume for bonus shares only, Previous Market price was 120 & Current is 140.
For 20% Stock Dividend of Bonus Shares (its Small Stock dividend because equal or less than 25%)

No. of Par Value Bonus Par Value Premium Premium Total Total
Content
Shares Old Shares New old New before after
200000
Ord. Shares Capital 20000 100 4000 100 2400000
0
Shares Premium 20000 4000 20 40 400000 560000
100000
Retained Earning 440000
0
340000
Total Shar. Hold. E. 3400000
0
The Transaction of bonus shares will not affect Par value & Total Shares Holders Equity. This transaction
has changed No. of shares by new shares 20000 old shares *20% = 4000, Shares capital by multiplied
value of par & new no. of shares 4000 * 100 = 400000, Shares premium by the multiplied value of new
no. of shares with premium per shares 4000 * 40 = 160000. Because the bonus is paid out of profit
therefore retained earnings will decrease by total value of bonus shares 4000 * 140 = 560000. I

Owner equity is the pledge/guarantee of the company, not every situation can issue multiple shares.
Ordinary shares capital and share premium these are called capital reserve of the company.
Retained earning and total share holder Equity are the revenue reserve, RE se nakil ke capital share me
add karthe he, par value pe bonus share ap ke financial statement pe record hota he. Total after is
means paid-up capital

For 40% Stock Dividend or Bonus Shares (its Large Stock dividend because greater than 25%)

No. of Par Value Bonus Par Value Premium Premium Total Total
Content
Shares Old Shares New old New before after
200000
Ord. Shares Capital 20000 100 8000 100 2800000
0
Shares Premium 20000 8000 20 40 400000 400000
100000
Retained Earning 200000
0
340000
Total Shar. Hold. E. 3400000
0
The Transaction of bonus shares will not affect Par value & Total Shares Holders Equity. This transaction
has changed No. of shares by new shares 20000 old shares *40% = 8000, Shares capital by multiplied
value of par & new no. of shares 8000 * 100 = 800000, Shares premium by the multiplied value of new
no. of shares with premium per shares 8000 * 0 = 0. Because the bonus is paid out of profit therefore,
retained earnings will decrease by total value of bonus shares 8000 * 100 = 800000. Large stock dividend
will affect the premium (premium will not be countable).

 Show impact of 4 for 2 Stock Split on all Contents of Shares Holders Equity of 2019.
The transaction of Stock Split will only affect the No. of Shares & values like Par Value & Market
Value.
Total No. of New Shares = (Receive Shares / Surrender Shares) * old no. of shares
Total No. of New Shares = (4 /2) * 20000 = 40000
Any Value per Share = (Surrender Shares / Receive Shares) * any value per share
 Par Value per share = (2/4) * 100 = 50, Similarly applied for Market & Book Values

 Show Impact of 3 for 9 Reverse Stock Split on all Contents of Shares Holders Equity of 2019.

Total No. of New Shares = (Surrender Shares / Receive Shares) * old no. of shares
Total No. of New Shares = (3 /9) * 10000 = 3333.3333
Any Value per Share = (Receive Shares / Surrender Shares) * any value per share
Par Value per share = (9/3) * 100 = 300, Similarly applied for Market & Book Values
 Show the impact of 20% Repurchase of Stock (Treasury Stock) of 2019. Also prove its same as cash
dividend by post event Market Price Comparison

No. of Par Value Total

Content Total after
Shares Old before
200000
Ord. Shares Capital 20000 100 2000000
0
Shares Premium 20000 20 400000 400000
100000
Retained Earning 1000000
0
Repurchase Stock (4000) 120 (480000)
340000
Total Shares Holders Equity 16000 2920000
0
The Transaction of Treasury Stock or Repurchase of stock will not affect anything except total Shares
holder’s equity & its subsequent elements, by the amount of Repurchase. Repurchase stock is same as
Dividend let assume no tax world and Cash dividend has also paid 20% see the impact here below given
table. Cash dividend amount be 20000 * 120 * 20% = 480000. Dividend paid out of Retained Earning. So
this will also show the same amount of Total Shares Holders Equity.

No. of Par Value Total

Content Total after
Shares Old before
200000
Ord. Shares Capital 20000 100 2000000
0
Shares Premium 20000 20 400000 400000
100000
Retained Earning 520000
0
340000
Total Shares Holders Equity 2920000
0

 Calculate Dividend Ratio, Dividend Payout, Dividend Yield & EPS.

From the given data:
Dividend Ratio is given 20%
Dividend Payout = Dividend per share / Earning Per share = 20 / 50 = 40%
Dividend per share = Total Dividend Declared / No. of Shares = (20000 * 100 * 20%) / 20000 = Rs. 20
Earnings Per share = Net Profit / No. of Shares = 1000000 / 20000 = Rs. 50
Dividend Yield = Dividend per share / Market price per share = Rs. 20 / Rs. 100 = 20%
 Prove dividend relevancy or Irrelevancy by assuming 15% & 20% dividend Payout Ratio with Market rate
of return 12% & 15% in Walter’s & Gorden Stock Valuation Model and Also prove assuming 0% & 20%
dividend Ratio in M & M Stock Valuation Model
Calculation for Price of Share if EPS Rs. 100, Ks 12% and Respective Rm & DP is mentioned in each
case
 Ks 0.12 Rm 0.12 DP 0.15
EPS 100 Rm 0.15 DP 0.2
           
    Rm 0.15 Rm 0.12
D 15 20 15 20
D / Ks 125 166.6667 125 166.6667
E–D 85 80 85 80
Rm * (E-D) 12.75 12 10.2 9.6
(Rm * (E-D)) / Ks 106.25 100 85 80
((Rm * (E-D)) / Ks)/ Ks 885.417 833.3333 708.333 666.6667
(D / Ks) + ((Rm * (E-D)) / Ks)/ Ks 1010.42 1000 833.333 833.3333
           
D 15 20 15 20
b = 1 – DP 0.85 0.8 0.85 0.8
Rm 0.12 0.15 0.12 0.15
g = b * Rm 0.102 0.12 0.102 0.12
Ks – g 0.018 0 0.018 0
D / (Ks-g) 833.333 Infinite 833.333 Infinite
           
Rm 12% Rm 12% Rm 15% Rm 15%
Walter's Pricing Model
DP 15% DP 20% DP 15% DP 20%
  833.333 833.3333 1010.42 1000
           
Rm 12% Rm 12% Rm 15% Rm 15%
Gorden's Pricing Model
DP 15% DP 20% DP 15% DP 20%
    833.333 833.3333 Infinite Infinite

Dividend is paid Dividend is not paid

P1 = Po(1+Ks) – D1 100(1+12%) – 10 = 79.28 100(1+12%) – 0 = 89.28

Current Profit After Tax 1000,000 1000,000

Less : Dividend (20000*50*20%) =200,000 0
Retained Earning 800,000 1,000,000
Financing required for New Project 2,000,000 2,000,000
Financing by New Shares 1,200,000 1,000,000
New No. of Shares to be issued 1,200,000/79.28 = 15,136.23 1000000/89.28 = 11,200.717
Total No. of Shares (new & old) 35,136.23 31,200.717
Market Value of Firm (Equity) 35,136.23*79.28 = 2,785,600 31,200.717*89.28=2,785,600
Hence M & M Proposition dividend is Irrelevance to Market value of firm - Proved

 Describe the impact (Directly or Indirectly) of all Kinds of dividend on Share value (via demand or Supply
pressure)

Do = current / paid / previous / existing / preceding

D1 = Expected / coming / forecasted / future dividend

D1 = Do + Do * g

D1 = Do (1 + g)

Ks = (D1 / Np) + g

D1 is not given but Do is given, make the formula with help of Do

Ks = (Do(1+g) / Np) + g