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PRIYANKA SAXENA
Meaning of dividend- Dividend is a part of retained earning which is distributed among the shareholders on equity / Pref. shares ,they hold Meaning of dividend policy A question in front of management is either to retain the profit or to distribute it with an objective to maximize shareholders wealth. A dividend policy is such which explains how much is to be paid and how much is to be retained
STABILITY OF DIVIDENDS
It is considered a desirable policy . It means regularity in paying some dividend annually .Three forms of stability may be distinguished 1. Constant dividend per share 2. Constant Dividend payout ratio 3. Constant dividend per share plus extra dividend
This policy is desirable where earnings are fluctuating . Merits of stability of dividends 1. Resolution of investors uncertainty 2. Investors desire for current income 3. Raising additional finance
FORMS OF DIVIDENDS
Cash dividends Bonus Shares
DIVIDEND THEORIES
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On the relationship between dividend policy and value of firm, different theories have been advanced .these theories can be grouped into two categories Theories that consider dividend decisions to be relevant Theories that consider dividend decisions to be irrelevant
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Prof. James. E. Walter argues that the choice of dividend policy always affects the value of firm. It is based on following assumptionsInternal Financing Constant return and cost of capital 100% payout or retention Constant EPS and DIV Infinite time
Walters
formula to determine the market price per share is as followsp= DIV/k + r(EPS-DIV)/k/k
P=Market price per share DIV= Dividend per share EPS=Earning per share r = Firms rate of return k- Firms cost of capital or capitalization rate
Growth Firms -Internal rate more than opportunity cost of capital (r>k) Normal Firms Internal rate equals opportunity Cost of capital (r=k) Declining Firms- Internal rate less than opportunity cost of capital ( r<k)
GORDONS MODEL
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Myron Gordon develops one very popular model explicitly relating to the market value of the firm to dividend policy. This model is based on following assumptionsAll equity firm No external financing Constant return Constant cost of capital Perpetual earning No taxes Constant Retention Cost of capital greater than growth rate
According
to the Gordons model , the market value of a share is equal to the present value of an infinite stream of dividend received by the shareholders . Thus the formula is Po= DIV1 / k-g or Po= EPS1(1-b)/ k-br EPS1= Earning per share k =cost of capital r= rate of return b= retention ratio g= br = growth rate
In
the first situation when the firm pays the dividends, shareholders get cash in their hands, but the firms assets reduce. What shareholders gain in the form of cash dividends, they lose in the form of their claims on the assets. There is no net gain or loss. Since it is a fair transaction under perfect capital market conditions, the value of the firm will remain unaffected. In the second situation, when the firm issues new shares to finance the payment of dividends, two transactions take place. First, the existing shareholders get cash in the form of dividends
Perfect
Under the MM theory , r will be equal to k , and identical for all the shares . As a result , the prices of each share must adjust so that the rate of return and the capital gains will be equal to k on each share.
Thus the minimum rate of return may be calculated as follows -r = Dividends+ capital gains /Share price Or r= DIV+(P1-Po)/ Po
RELEVANCE OF THE DIVIDEND POLICY UNDER MARKET IMPERFECTIONSThe MM theory on simplifying assumption. But these assumption may not be found valid under in practiced . The following are the situations where MM hypothesis may go wrong Uncertainty and shareholders preference Transaction cost and case against the dividend payments Tax differentials Informational content of dividends
BY:-
PRIYANKA
SAXENA
20