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8/13/2019 Dividend Policy Business Law
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Dividend Policy
PRESENTED BY:MANMEET SINGH
KAWALPREET KAUR
AMANPREET KAUR
EKTA VERMA
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WHAT IS DIVIDEND?
The term dividend refers to that part of profits
of a company which is distributed by the
company among its shareholders.
It is the reward of the shareholders for
investments made by them in the shares of the
company.
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DIVIDEND POLICY
The dividend policy of a firm determines what
proportion of earnings is paid to shareholders
by way of dividends and what proportion is
ploughed back in the firm for reinvestment
purposes.
The most controversial issue arises is what is
the relationship between dividend policy andmarket price of equity shares.
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Models
In which investment and dividend decision are
related or theory of relevance.
In which investment and dividend decisions
are not related or theory of irrelevance.
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Theory of relevance
Walter model
Gordon model
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Walters approach
James Walter has proposed the model.
It is based on the relationship between the firms
Return on investment i.e., r
Cost of capital, i.e., k If r>k i.e., if the firm earns a higher rate of return on
its investment than the required rate of return, thefirm should retain the earnings. Such firms aretermed as growth firms and their payout ratio iszero.
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Assumptions
The firm is an all- equity financed entity.
Further it will rely only on retained earnings
to finance its future investments. This means
that the investment decision is dependent on
the dividend decision.
The rate of return on investment is constant.
The firm has an infinite life
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Implications
R>k ,the price per share increases as thedividend payout ratio decreases. The optimumpayout ratio for a growth firm is nil.
R = k, the price per share does not vary withchanges in dividend payout ratio. Theoptimum payout ratio for a normal firm isirrelevant.
R < k, the price per share increases as thedividend payout ratio decreases. The optimumpayout ratio for a firm is 100% .
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Gordon model
Myron Gordon proposed a model of stock
valuation using the dividend capitalizationapproach.
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Assumptions
Retained earnings represent the only source of
financing for the firm.
The rate of return on firm investment is
constant.
The growth rate of the firm is the product of its
retention ratio and its rate of return.
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The firm has a perpetual life.
Tax does not exist.
The cost of capital for the firm remainsconstant and it is greater than the growth rate.
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Implications
R>k ,the price per share increases as thedividend payout ratio decreases. The optimumpayout ratio for a growth firm is nil.
R = k, the price per share does not vary withchanges in dividend payout ratio. Theoptimum payout ratio for a normal firm isirrelevant.
R < k, the price per share increases as thedividend payout ratio decreases. The optimumpayout ratio for a firm is 100% .
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TRADITIONAL THEORY
It is given by Graham and Dodd. Acc to this
approach in the valuation of shares the weight
attached to its dividend is equal to four times
the weight attached to retained earnings.
The major contention of the traditional
position is that a liberal payout policy has a
favorable impact on stock price
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Criticism
The equation a) is misspecified because it
omits risk which is an important determinant
of price.
The omission of risk imparts an upward bias to
b, the coefficient of dividend and downward
bias to c, the coefficient of retained earnings.
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Residual approach
This theory assumes that investors do notdifferentiate between dividends and retentions by
the firm. Their basic desire is to earn higher return on their
investment.
In case the firm has profitable investmentopportunities giving a higher rate of return thanthe cost of retained earnings, the investors wouldbe content with the firm retaining the earnings to
finance the same.
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However, if the firm is not in a position to findprofitable investment opportunities, the
investors would prefer to receive the earnings
in the form of dividends. Thus, a firm should retain the earnings if it has
profitable investment opportunities, otherwise
it should pay them as dividends.
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MILLER AND MODIGLIANI
MODEL
Dividend policy has no effect on the market
price of the shares and the value of the firm is
determined by the earning capacity of the firmor its investment policy.
The splitting of earnings between retentions
and dividends, may be in any manner the firmlikes, does not effect the value of the firm.
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Assumptions
Investment opportunities and future profits of
the firm are known with certainty.
There are no taxes.
Floatation costs are nil.
Investment and financing decisions are
independent. Information is freely available to everyone
equally.
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Criticism
Regarding issue cost or floatation cost.
Regarding tax position.
Informational content.
Uncertainty and fluctuations.
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IMPLICATIONS
MM dividend irrelevance theorem.
Exist on their leverage irrelevance theorem.
There is no conflict between dividend
capitalization approach.
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THANKYOU
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