Dividendpolicy by pakistani studend
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The document discusses dividend and retention policy. It defines dividends and examines different theories on dividend policy, including Walter's model, Gordon's model, Modigliani-Miller's irrelevance theory, and the traditional approach. Key points covered include the assumptions and formulas of different models and how they assess the impact of dividends on firm value. The document also analyzes factors influencing dividend policy decisions.
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Dividendpolicy by pakistani studend
- 1. DIVIDEND AND RETENTION POLICY By : Shafqat Ali MBA iv: University of Azad Jammu and Kashmir Muzaffarabad. Dated: 25-02-2013
- 2. Introduction : What is Dividend? What is dividend policy? Theories of Dividend Policy Relevant Theory WaltersModel 赫看姻糸看稼s Model Irrelevant Theory M-Ms Approach Traditional Approach
- 3. What is Dividend? A dividend is a distribution to shareholders out of profit or reserve available for this purpose. - Institute of Chartered Accountants of India
- 4. Forms/Types of Dividend On the basis of Types of Share Equity Dividend Preference Dividend On the basis of Mode of Payment Cash Dividend Stock Dividend Bond Dividend Property Dividend Composite Dividend
- 5. Cont d. On the basis of Time of Payment InterimDividend Regular Dividend Special Dividend
- 6. What is Dividend Policy : Dividend policy determines the division of earnings between payments to shareholders and retained earnings. - Weston and Bringham
- 7. Cont d. Dividend Policies involve the decisions, whether- To retain earnings for capital investment and other purposes; or To distribute earnings in the form of dividend among shareholders; or To retain some earning and to distribute remaining earnings to shareholders.
- 8. Factors Affecting Dividend Policy Legal Restrictions Magnitude and trend of earnings Desire and type of Shareholders Nature of Industry Age of the company Future Financial Requirements Taxation Policy Stage of Business cycle
- 9. Cont d. Regularity Requirements of Institutional Investors
- 10. Dimensions of Dividend Policy Pay-out Ratio Funds requirement Liquidity Access to external sources of financing Shareholder preference Difference in the cost of External Equity and Retained Earnings Control Taxes
- 11. Cont d. Stability Stable dividend payout Ratio Stable Dividends or Steadily changing Dividends
- 12. Types of Dividend Policy Regular Dividend Policy Stable Dividend Policy Constant dividend per share Constant pay out ratio Stable rupee dividend + extra dividend Irregular Dividend Policy
- 14. Dividend Theories 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) Walters 赫看姻糸看稼s Model Model Modigliani and Traditional Millers Model Approach
- 16. Walters Model Prof. James E Walter argued that in the long- run the share prices reflect only the present value of expected dividends. Retentions influence stock price only through their effect on future dividends. Walter has formulated this and used the dividend to optimize the wealth of the equity shareholders.
- 17. Assumptions of Walters Model: Internal Financing constant Return in Cost of Capital 100% payout or Retention Constant EPS and DPS Infinite time
- 18. Formula of Walters 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 firms investment or Internal Rate of Return k = Cost of Equity Capital
- 19. Illustration : Growth Firm (r > k): r = 20% k = 15% E = Rs. 4 If D = Rs. 4 P = 4+(0) 0.20 /0 .15 = Rs. 26.67 0.15 If D = Rs. 2 P = 2+(2) 0.20 / 0.15 = Rs. 31.11 0.15
- 20. Illustration : Normal Firm (r = k): r = 15% k = 15% E = Rs. 4 If D = Rs. 4 P = 4+(0) 0.15 / 0.15 = Rs. 26.67 0.15 If D = Rs. 2 P = 2+(2) 0.15 / 0.15 = Rs. 26.67 0.15
- 21. Illustration : Declining Firm (r < k): r = 10% k = 15% E = Rs. 4 If D = Rs. 4 P = 4+(0) 0.10 / 0.15 = Rs. 26.67 0.15 If D = Rs. 2 P = 2+(2) 0.10 / 0.15 = Rs. 22.22 0.15
- 22. Effect of Dividend Policy on Value of Share Case If Dividend Payout If Dividend Payout ratio Increases Ration decreases 1. In case of Growing Market Value of Share Market Value of a share firm i.e. where r > k decreases increases 2. In case of Declining Market Value of Share Market Value of share firm i.e. where r < k increases decreases 3. In case of normal firm No change in value of No change in value of i.e. where r = k Share Share
- 23. Criticisms of Walters Model No External Financing Firms internal rate of return does not always remain constant. In fact, r decreases as more and more investment in made. Firms cost of capital does not always remain constant. In fact, k changes directly with the firms risk.
- 24. 赫看姻糸看稼s Model According to Prof. Gordon, Dividend Policy almost always affects the value of the firm. He Showed how dividend policy can be used to maximize the wealth of the shareholders. The main proposition of the model is that the value of a share reflects the value of the future dividends accruing to that share. Hence, the dividend payment and its growth are relevant in valuation of shares. The model holds that the shares market price is equal to the sum of shares discounted future dividend payment.
- 25. Assumptions: Allequity firm No external Financing Constant Returns Constant Cost of Capital Perpetual Earnings No taxes Constant Retention Cost of Capital is greater then growth rate (k>br=g)
- 26. Formula of 赫看姻糸看稼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
- 27. Illustration : Growth Firm (r > k): r = 20% k = 15% E = Rs. 4 If b = 0.25 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)
- 28. 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)
- 29. Illustration : Declining Firm (r < k): r = 10% k = 15% E = Rs. 4 If b = 0.25 P0 = (0.75) 4 = Rs. 24 0.15- (0.25)(0.10) If b = 0.50 P0 = (0.50) 4 = Rs. 20 0.15- (0.5)(0.10)
- 30. Criticisms of 赫看姻糸看稼s model As the assumptions of Walters Model and 赫看姻糸看稼s Model are same so the 赫看姻糸看稼s model suffers from the same limitations as the Walters Model.
- 32. Modigliani & Millers Irrelevance Model Value of Firm (i.e. Wealth of Shareholders) Depends on Firms Earnings Depends on Firms Investment Policy and not on dividend policy
- 33. Modigliani and Millers Approach Assumption Capital Markets are Perfect and people are Rational No taxes Floating Costs are nil Investment opportunities and future profits of firms are known with certainty (This assumption was dropped later) Investment and Dividend Decisions are independent
- 34. M-Ms Argument If a company retains earnings instead of giving it out as dividends, the shareholder enjoy capital appreciation equal to the amount of earnings retained. If it distributes earnings by the way of dividends instead of retaining it, shareholder enjoys dividends equal in value to the amount by which his capital would have appreciated had the company chosen to retain its earning.
- 35. Hence, the division of earnings between dividends and retained earnings is IRRELEVANT from the point of view of shareholders.
- 36. Formula of M-Ms Approach 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
- 37. 1 (nD1+nP1) nPo = (1 + p) The expression of the outstanding equity shares of the firm at time 0 is obtained as: 1 {nD1+(n + m)P1- mP1} nPo = (1 + p)
- 38. mP1 = I (X nD1) Where, X = Total net profit of the firm for year 1 nPo 1 [nD1+ (n + m)P1 {I (X = nD1)}] (1 + p) nPo 1 nD1+ (n + m)P1 I +X nD1 = (1 + p)
- 39. nPo 1 (n + m)P1 I +X = (1 + p)
- 40. Criticism of M-M Model No perfect Capital Market Existence of Transaction Cost Existence of Floatation Cost Lack of Relevant Information Differential rates of Taxes No fixed investment Policy Investors desire to obtain current income
- 41. Traditional Approach This theory regards dividend decision merely as a part of financing decision because The earnings available may be retained in the business for re-investment Or if the funds are not required in the business they may be distributed as dividends. Thus the decision to pay the dividends or retain the earnings may be taken as a residual decision
- 42. This theory assumes that the investors do not differentiate between dividends and retentions by the firm Thus, a firm should retain the earnings if it has profitable investment opportunities otherwise it should pay than as dividends.
- 43. Synopsis Dividend is the part of profit paid to Shareholders. Firm decide, depending on the profit, the percentage of paying dividend. Walter and Gordon says that a Dividend Decision affects the valuation of the firm. While the Traditional Approach and MMs Approach says that Value of the Firm is irrelevant to Dividend we pay.
- 44. Bibliograph y Google Financial management by prasanna chandra.