ASSESSMENT: QUIZ 5%

DIVIDEND POLICY (MAF603)

GROUP: AC220B4K

LECTURER'S NAME: PUAN BEDAH BINTI AHMAD

SUBMISSION DATE: 31 OCTOBER 2020

NO GROUP MEMBERS NAME STUDENT ID

1. FARAH NAJWA BINTI HAMDAN 2020963757
2. ZURAINI BINTI HANUDIN 2020971743

1. According to the residual theory of dividends, advise Mr. Johnny from JCR BHD
on how a firm determines its dividend policy.

A residual dividend is a dividend policy that is adopted by the firms to distribute the
dividend to be paid to the shareholders. Firm that implies the residual dividend policy will
prioritize the available earnings to finance the capital expenditures and its positive net
present value investments over the shareholders dividend payment. 

In order to regulate the residual dividend policy, Mr. Johnny from JCR BHD should
determine the optimum capital budgeting by implementing the investment proposals that
have a positive net present value and also estimate the availability of investment
opportunities for a particular period.

Next, Mr. Johnny should estimate the funds needed which number of shares to carry
out the new investment while maintaining the ideal capital structure. To maintain an ideal
capital structure, JCR BHD should consider maximizing its market value and minimizing
its cost of capital as well as setting a target dividend payout ratio for a long-term and
short-term period. Besides, if JCR BHD uses its retained earnings to finance the
investment, the firm needs to determine how sufficient enough of its retained earnings
could support the optimal capital budget.

Last but not least, JCR BHD should make payment of the dividends to the
shareholders only if there are residual internal funds available after all the positive net
present value investment proposals have been funded.
2. Why should we expect a firm’s stock price to decline by approximately the amount
of the dividend payment on the ex-dividend date?

Ex-dividend date means the day for trading a stock without the subsequent value of
dividend. In other words, the investors who purchase the stock on or after the ex-
dividend date are not entitled to receive the next declared dividend payment except for
the existing shareholders. In fact, after ex-dividend date firm’s stock price usually will
drop and the reason why we should expect that is because to encourage the investor to
purchase the stock before ex-dividend date where they are willing to pay a premium.
This practice will lead to increase in stock price up to the ex-dividend date and it will also
allow sufficient time to transfers the stock on the book of firm. The decline of the stock
price at this date is really based on market sentiment rather than any set rule. Since the
dividend is fundamentally from retained earnings, thus it will technically degrade the
value of the company. If the stock price is trading excluding the value of next dividend
payment, it is called as having “gone ex-dividend”. During this time, the symbol “XD” will
stated next to its stock symbol on trading platforms.

3. Modigliani and Miller (1961) hypothesized “dividend policy has no effect to the
share price” in a world without taxes. Discuss the statement.
Based on the statement above, we can clarify that the shareholders wealth is affected by
the investment decision not how it distributes the dividend income. This is because, a
firm may increase their earnings through financing a good investment project that can
enhance the value of firm as mostly investors are only concerned on getting high returns
from their investment.
According to Modigliani and Miller perspective, whether firms able to pay dividend or not,
the investors are capable enough to create their own personalized stream of income by
selling part of their investment or they may also could reinvest the dividend received by
buying firm’s stocks to earn the cash flows that they expected would get. As such, the
dividend is irrelevant to investors meaning that between dividend payment and retained
earnings would not affect the shareholder’s wealth by the current or future dividend
decisions of the firms as they can effectively creating homemade dividend. Therefore,
the Modigliani and Miller hypothesis is clearly stating that dividend policy of company
has no influence on the investor’s investment decision.
The Modigliani and Miller theory is supported by the following assumptions:
I. There are no transaction cost and floatation cost when the company issues
shares.
II. Taxes do not exist.
III. There is no impact of leverage on the cost of capital of the company.
IV. Dividend policy has no impact on the capital budgeting of the company.
V. A perfect capital market exist where all the investors are rational.
VI. High retained earnings is used to finance all of the positive net present value
project when the dividend paid is low.
VII. No risk of uncertainty.

In real life, none of these assumptions are true. The company need to bare the
transaction and floatation cost to issue shares. Taxes are mandatory for all and present
in capital market. Perfect capital market does not exists. The assumption of no
uncertainty is unrealistic. The dividends policy are relevant considering certain
condition. Miller hypothesis might be true theoretically but it is not applicable in the
practical world.
References:

Question 1

1. https://www.investopedia.com/terms/o/optimal-capital-structure.asp

2. https://www.investopedia.com/terms/r/residual-dividend.asp#:~:text=A%20residual
%20dividend%20is%20a,before%20paying%20dividends%20to%20shareholders.

3. https://www.wisdomjobs.com/e-university/financial-management-tutorial-
289/determining-the-optimal-capital-budget-6637.html

4. https://www.fool.com/knowledge-center/the-5-steps-to-capital-budgeting.aspx

Question 2

1. https://www.investopedia.com/articles/investing/091015/how-dividends-affect-stock-
prices.asp#:~:text=After%20a%20stock%20goes%20ex,price%20in%20the%20short
%2Dterm.

2. https://finance.zacks.com/stock-price-change-dividend-paid-3571.html

3. https://www.investopedia.com/ask/answers/042915/what-difference-between-record-
date-and-exdividend-date.asp

Question 3

1. Rodziah Abd Samad. Shelia Christable. Mohd Nizal Haniff. Financial Management for
Beginners 4th Edition.
2. https://www.investopedia.com/terms/d/dividendirrelevance.asp
3. https://efinancemanagement.com/dividend-decisions/modigliani-miller-theory-on-
dividend-policy

4. Theories of Dividend: Walter’s model, Gordon’s model and Modigliani and Miller’s
Hypothesis. Your Article Library. March 2014.