Professional Documents
Culture Documents
Dividend Policy
Dividend Policy
POLICY
By :Dr.Rajinder S.Aurora
Professor in Finance
IBS, Mumbai
Subject Facilitator: Financial Management
Introduction:
o What is Dividend?
o What is dividend policy?
o Theories of Dividend Policy
o Relevant Theory
• Walter’s Model
• Gordon’s Model
o Irrelevant Theory
• M-M’s Approach
• Traditional Approach
What is Dividend?
Preference Dividend
Stock Dividend
Bond Dividend
Property Dividend
Composite Dividend
Contd….
o Legal Restrictions
o Magnitude and trend of earnings
o Desire and type of Shareholders
o Nature of Industry
o Age of the company
o Future Financial Requirements
o Taxation Policy
o Stage of Business cycle
o Regularity
o Requirements of Institutional
Investors
Dimensions of Dividend Policy:
o Pay-out Ratio
o Funds requirement
o Liquidity
o Access to external sources of financing
o Shareholder preference
o Difference in the cost of External Equity
and Retained Earnings
o Control
o Taxes
Contd
o Stability
Stable dividend payout Ratio
Dividends
Types of Dividend Policy:
Irrelevance Theories
Relevance Theories
(i.e. which consider dividend
(i.e. which consider dividend
decision to be irrelevant as it
decision to be relevant as it
does not affects the value of the
affects the value of the
firm)
firm)
Walter’ Gordon’s
s Model
Model
Infinite time
Formula of Walter’s Model
D+ r (E-D)
P = k
k
Where,
P = Current Market Price of equity
share E = Earning per share
D = Dividend per share
(E-D) = Retained earning per share
r = Rate of Return on firm’s investment or Internal
Rate of Return
k = Cost of Equity Capital
Illustration:
No External Financing
Firm’s internal rate of return does not always
remain constant. In fact, r decreases as more
and more investment in made.
Firm’s cost of capital does not always remain
constant. In fact, k changes directly with the
firm’s risk.
Gordon’s Model
o No external Financing
o Constant Returns
o Perpetual Earnings
o No taxes
o Constant Retention
o Cost of Capital is greater then growth rate
(k>br=g)
Formula of Gordon’s Model
E (1 – b)
P = K - br
Where, P
= Price
E = Earning per Share
b = Retention Ratio
k = Cost of Capital br
= g = Growth Rate
Illustration:
P0 = (0.75) 4 = Rs. 30
0.15- (0.25)(0.20)
If b = 0.50
P0 = (0.50) 4 = Rs. 40
0.15- (0.5)(0.20)
Illustration
:
Normal Firm (r = k):
r = 15% k = 15% E = Rs. 4
If b = 0.25
P0 = (0.75) 4 = Rs. 26.67
0.15- (0.25)(0.15)
If b = 0.50
P0 = (0.50) 4 = Rs. 26.67
0.15- (0.5)(0.15)
Illustration:
Firm’s
Earnings
Depends
on
Assumption
o Capital Markets are Perfect and people
are Rational
o No taxes
are independent
M-M’s Argument
1 ( D1+P1 )
P = (1 + p)
o
Where,
Po = Market price per share at time 0,
D1 = Dividend per share at time 1,
P1 = Market price of share at time 1
Criticism of M-M Model