DIVIDEND
INTRODUCTION

Dividend is a part of after tax profit which is distributed to owners ie. Shareholders.

Dividend decision is a co’s policies to distribute the earning b/w payments to shareholders
and retained earnings.

Significance:

Growth and dividend distribution balance

Critical influence on value of the firm

Long term financing decision and wealth max

Affect market price if no dividend paid

Retained earnings helps firm to concentrate on growth, expansion , modernization etc.

Affect finance structure, flow of funds, corporate liquidity, stock price and growth of co as well as
investors satisfaction.
FACTORS

General stats of economy
state of capital market

Legal restrictions
contractual restrictions

Tax policy of government
inflation

Access to capital market
stability of dividend

Earnings of the co.
Liquidity position of co.

Past dividend rates
growth needs of the firm

Cost of capital
age of co.

Nature of the industry
TYPES OF DIVIDEND

Cash dividend – pay in cash

Stock dividend – additional shares of common stocks / bonus shares

Objectives is to cash outflow restrained, lower rate of dividend, growth and expansion

Advantages: widen the mkt for its shares, growth and expansion, min cost of issue, remedy for
under capitalization, marketability

Disadvantages: obligation of additional dividend, prevent new investor, control over
management is not diluted, may receive lesser dividend, disappoint due to no cash

Property dividend- non monetary

Scrip dividend/bond dividend – like promissory notes or bonds

Liquidating dividend- before shutting down
DIVIDEND THEORIES

Relevance theory - dividend decision affect value of the firm

Walter and Gordons model are relevance theory

Irrelevance theory – dividend decision do not affect value of the firm.

Walter Model (Relevance Theory)

James Walter choice of dividend policy always affect value of the firm.

Relationship b/w rate of return and cost of capital is very essential.

Assumption: life of the firm is infinite, constant dividend and earning per share, total
payout or retention
WALTER MODEL

P = D + R /Ko (E-D) / K0
p – mkt value of share , R – Rate of return , D –
Dividend
E- earning per share , K – cost of capital.

Example: ABC has cap rate of 10%, EPS Rs. 20, dividend Rs. 10 calculate share price
if 20% roi. If dividend is Rs. 15 / Rs.5 what is share price.
Soln: P = 10 + 0.2/.1 ( 20 -10 ) / 0.10
P = 15 +0.2/.1(20-15) / 0.10
P = 5 + 0.2/ .1 (20-5) / 0.1
= Rs. 300
= Rs.
250
=Rs. 350
For different dividend value of the firm will change.
GORDEN MODEL

Dividend are relevant, firms decisions affect the value.

Proposed by Gordon Myron.

Share price is dependent on payout ratio.

Stock valuation using dividend capitalization approach.

Assumptions:

No debt only equity
investment are exclusively financed by retained earnings- no external
finance
ROI is constant
Cost of capital is constant and greater than growth rate

No corporate taxes
P = E (1-b) / Ke-g
GORDEN MODEL

Following info , determine share price. EPS – Rs. 10,

Cap ratio – 15%, ROI - 14%
Soln:
Rs. 10( 1 – 0.4) / 0.15- 0.056
= Rs. 63.82
Retention ratio – 40%
g - 0.14 *0.4 = 0.056
IRRELEVANCY MODEL – MM THEORY

Dividends are relevant to value of firm

Value is determined by basic earning power and its business risk.

Assumptions: no taxes, fixed investment policy and no risk – uncertainty does not exists

Firm value when dividend paid: P1 = Po ( 1+k) – D1
issue of new shares delta n P 1 = I – (E – nD1)
amount required to be raised by
No. of additional shares to be issued Delta n = delta n P1 / P1
value of the firm Np 0 = ( n + delta n ) P1 – I +E
P0 – mkt value of share
K – discount rate
/ 1 +Ke
D1 – dividend end of year 1
I-net income
P 1 – mkt value at the end of year1
E- no of outstanding shares
EXAMPLE

ABC Co. Ltd belongs to a risk class for which the approximate capitalization rate is 10% . It
currently has an outstanding 30000 shares, which are selling in market at Rs 80.the company
is expecting a net income of Rs 400000 and it has a profitable investment(project)proposed
that costs Rs 600000.the company is interesting to declare a dividend of Rs 4 per share at the
end of financial year. Show that under MM hypothesis the payment of dividend does no
affect the value of the firm
Soln:
Value of firm when dividend are paid:
step 1 - share price at the end of year 1
P1 = 80 ( 1+.1) – 4 = Rs. 84
step 2 amount needed to raise through new shares
delta n p1 = 600000 - ( 400000 – 30000*4) = Rs. 320000
Step 3
No of additional share to be issued: 320000 / 84
Step 4
value of firm
= Rs. 2400000
= 3809.52
= (30000 + 3809.52) *84 -600000+400000 / 1.1
EXAMPLE
Value of firm when dividend are not paid paid:
step 1 - share price at the end of year 1
Rs. 80 = P1 /( 1+.1) = Rs. 88
step 2 amount needed to raise through new shares
delta n p1 = 600000 - 400000
= Rs. 200000
Step 3
No of additional share to be issued: 200000 / 88
Step 4
value of firm
= (30000 + 2272.72) *88
= 2272.72
-600000+400000 / 1.1
= Rs. 2400000
Dividend paid or not paid will not impact value of firm… in this case 2400000 is the
co. value.