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Dividend Policy Dividend Policy
Dividend Policy Dividend Policy
Dividend Policy
Policy
Dividend
The term ‘dividend’ refer to that part of
divisible profits among its shareholders.
In other words, dividend is that portion of
company’s profit which is distributed
among its shareholders as a percentage
of par value of share or at a fixed rate per
share according to the decision of its
board of directors
Interest VS Dividend
Interest is a payment to lenders A dividend is a discretionary
for a given period of time payment made to shareholders
3 4
Types of dividend
Dividends are a permanent distribution of residual
earnings/property of the corporation to its owners.
Dividends can be in the form of:
Cash
Scrip Dividend/Bonus/ (stock dividend)
If a firm is dissolved, at the end of the process, a final
dividend of any residual amount is made to the
shareholders – this is known as a liquidating dividend.
Types of Dividends
Regular Dividend
The dividend that is normally expected to
be paid by the firm.
Extra dividend
A nonrecurring dividend paid to
shareholders in addition to the regular
dividend. It is brought about by special
circumstances.
Cash Dividend
Additionally,
Flotation costs – low payouts can decrease the amount of
capital that needs to be raised, thereby lowering flotation
costs
Theory of Irrelevance
Bird In Hand theory
Tax preference theory
Information Content Hypothesis
Signaling:
The theories thus far have assumed that
investors and managers have the same
information set.
When it comes to prospect for the company,
managers may have better information than
investors.
Therefore unexpected changes in dividends may
transmit information to the market that it didn’t
know before.
Information Content Hypothesis
Signaling - continued
Managers don’t cut dividends unless the
firm is in financial distress.
It is therefore believed that firms do not
increase dividends beyond analyst's
expectations unless managers anticipate
stronger earnings than expectations.
Unexpected changes in dividends pass on
information to the market.
Dividends Policies
Stable dividend Policy
Constant
Constant Growth
Fixed Payment
Passive residual policy
Dividend Stability
Stability -- maintaining the position of the firm’s
dividend payments in relation to a trend line.
4 50% of earnings Earnings per share
Dollars Per Share
2
Dividends
1 per share
Time
Dividend Stability
Dividends begin at 50% of earnings, but are stable and
increase only when supported by growth in earnings.
Time
Dividend Policy in Practice
Residual Dividend Policy: Investors prefer
to have the firm retain and reinvest
earnings if they can earn a higher risk
adjusted return than the investor can.
Residual Dividend Policy suggests that
dividends should be that part of
earnings which cannot be invested at a
rate at least equal to the WACC.
Dividend Policy Classes
Residual Dividend Policy Steps:
1 Determine the optimal capital budget.
2 Determine the retained earnings that can be
used to finance the capital budget.
3 Use retained earnings to supply as much of
the equity investment in the capital budget as
necessary.
4 Pay dividends only if there are left-over
earnings.
Dividend Policy Classes
Stable, Predictable Dividend Policy: Due
to the possibility of a negative signal to
investors, many CFOs have set the
policy of never reducing their dividends.
Dividends are only increased if
management is certain future
earnings will support such a high
dividend.
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