Sangam University

Dividend policy
Dr. Sandeep Kumar Chaurasia
Assistant Professor
School of Management studies
 Content
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1. Dividend
2. Dividend decision and Dividend policy
3. Factors affecting dividend policy
4. Forms of dividend policy
5. Dividend model.
(i) Walter’s Model
(ii) Gordan’s Model
(iii) Modigliani Miller Model
 Meaning of Dividend
• The dividend is derived from the Latin word “ Dividendum” which means “that which
is to be divided”.
• This distribution is made out of the profits remained after deducting all expenses,
provision for taxation and transferring a reasonable amount to reserves.

• Dividend is that part of net profit which is paid in cash by the company to its
shareholders after exclusion of the retained profit.
A dividend may be defined as divisible profits which are distributed amongst the members of a company in
proportion of their shares in a manner as is prescribed by law.

According to ICAI- A dividend is a distribution to shareholders out of profit or Reserves available for the purpose.

Dividend cannot be declared by a company unless there is –

▪ Sufficient profit in the company

▪ Recommendation of the Board of Directors.

▪ An acceptance of the shareholders in the annual general meeting

 Dividend Decision and Dividend policy

Dividend decision is the determination of the percentage of

earnings to be paid by the company in cash to its shareholders
as dividend and the percentage of earnings to be retained by it
for financing its long term growth.
Dividend policy is a policy that determinates the quantum of
profit to be distributed as dividend.
Its also includes the determination of the principles,
Rules and procedure for the planning of distributing dividend
after deciding the rate of dividend .

• A Company’s dividend policy can be defined as the plan of

action adopted by its directors whenever the dividend
decision is to be made.
 Essentials of a Sound Dividend policy

1. Distribution of Dividend in Cash

2. Initially Lower Dividend
3. Increase in Dividend
4. Stability
5. Dividend out of Earning profits
Factors Determining Divided Policy
Nature of Earning- The amount and stability of earnings of a company is the
most important aspect of dividend policy, because dividends can be paid out of
present or past year profit.
 Types of dividend policy
1. Constant dividend per share.

2. Constant pay-out ratio or Constant percentage of net

earning.
 1. Constant dividend per share

EPS = Earning per share

DPS = Dividend per share
 2. Constant pay-out ratio

EPS = Earning per share

DPS = Dividend per share
 Forms of dividend policy
____
Types of security
_ _
___ Preference dividend
____ Equity dividend

Kinds of _ _ _
________ Trimmings of dividend __ Interim dividend
dividend _____
___ Regular dividend

_ __ Cash dividend
Medium of payment _____
___ Stock dividend
Scrip or bond dividend
 Dividend models
1.Walter’s Model
2.Gordan’s Model
3.Modigliani Millar Model
 1. Walter’s Model
A firm should retain it earnings if the return on investment
exceed the cost of capital and in the opposite case, it should
distribute its earnings to the shareholders.
The dividend policy of a firm is based on the relationship
between the internal rate of return (r) earned by it and the
cost of capital or required rate of return (Ke).
 Assumptions
• The internal rate of return (r) and the cost of capital (Ke)
are constant.
All new investment opportunities of the firm are to be
financed through retained earning only and no external
finance is available to the firm.
The firm has perpetual or an infinite life.
1. Growth Firm (when r>Ke) :- If r> Ke, the dividend payout
ratio should be zero, i.e. Retention of 100% profits.
Declining Firm (when r<Ke) :- If r<Ke, the dividend
payout ratio should be 100% and the firm should not retain
any profits.
Normal Firm (when r=Ke) :- If r = Ke, the dividend is
irrelevant and dividend policy will not affect the market
value of shares.
Formula:-
P =___
D + r ( E – D ) / Ke
______________
Ke
Ke
Where;
P= market price per share
D= dividend per share
r= internal rate of return
E= earning per share
Ke= cost of equity capital or capitalisation rate
 2. Gordan’s Model
Market value of a share, according
to Gordon is equal to the present
value of its expected future
dividends.
 Assumptions
• The internal rate of return (r) and the cost of capital (Ke) of
firm remains constant.
• The firm operates investment activities only through equity.
• There does not exists corporate taxes.
1. Growth Firm ( where r > Ke )

2. Normal Firm ( where r = Ke )

3. Declining Firm ( where r < Ke )

Formula:-
P =____
D Or E ( 1 – b )
____________
Ke - g Ke - br
Where;
P= price for share
D= expected dividend per share
E= earning per share
Ke= cost of capital or capitalisation rate
b= retention ratio (1-payout ratio) i.e. the percentage of earning
retained
br= g= growth rate i.e. r
 3. Modigliani and Miller
Model ( M – M Model )
Modigliani and Miller says that dividend
decisions are retained earning decisions do
not influence the market value of the shares
i.e. dividend policy is irrelevant of valuation.
 Assumptions
• There exist a perfect capital market.
There are no floatation or transaction cost.
There are no taxes.
Future earnings are known with certainty.
Formula:-
Po = D1 + P1
_______
1 - Ke
Where;
Po= market price per share at the beginning of the period or
prevailing market price of a share
D1= dividend to be received at the end of the period
P1= market price per share at the end of the period
Ke= cost of equity capital or capitalisation rate
Thank you