Dividend Policy 181r3l

DIVIDEND POLICY

What is dividend ??? 

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The term dividend refers to that portion of profit which distributed among the owners/shareholders of the company. It is the reward of the shareholders for investments made by them in the shares of the company. The investors are interested in earning the maximum ROI and to maximize their wealth, while a company, on the other hand, needs to provide funds to finance its long-term growth.

What is dividend decision ??? 

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Should the profit be ploughed back to finance the investment decisions? Whether any dividend be paid? If yes, how much dividend be paid? When these dividend be paid? Interim or Final? In what form the dividends be paid? Cash dividend or stock dividend?

Dividend Policy 

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Dividend policy of a firm affects both the longterm financing and the wealth of shareholders. It deals with the firm‟s decision to pay dividends must be reached in such a manner so as to equitably apportion the distributed profits and retained earnings. The company should, therefore, distribute a reasonable amount as dividends to its and retain the rest for its growth and survival.

Dividend policy and value of the firm 

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Dividend policy is basically concerned with deciding whether to pay dividend in cash now, or to pay increased dividends at a later stage or distribution of profits in the form of bonus share. “What is sound rational for dividend payments?” in the light of the objective of maximization of the value of the share

Dividend policy and value of the firm 

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Different models have been proposed to evaluate the dividend policy decision in relation to value of the firm. Two schools of thought have emerged on the relationship between the dividend policy and the value of the firm.  Relevance

of dividend policy.  Irrelevance of dividend policy.

Relevance of dividend policy 

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The firm pay dividend and view such dividend payments positively. The investors also expect and like to receive dividend income on their investments. The firms not paying dividends may be adversely rated by the investors. It may be argued that the dividend policy has an effect on the market value of share and the value of firm.

Walter‟s Model  1.

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Assumption: All the investment proposals of the firm are to be financed through the retained earning only and no external finance is available to the firm. The business risk of the firm remains same even after fresh investment decision are taken. In other words ROI „r‟ and cost of capital „k‟ are constant. The firm has an indefinite life.

Walter‟s Model 

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This model considers that the investment decision and dividend decisions are interlinked. A firm should or should not pay dividends depends upon whether it has got the suitable investment opportunities to invest the retained earnings or not.

Walter‟s Model 

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According to this model, a firm can maximize the market value of its share and value of the firm by adopting a dividend policy as follows: If r>k - retention of 100% profit If r < k – pay 100% profit as dividend If r = k – the dividend is irrelevant

P = D + (E – D) (r/k) k k

Gordon‟s Model 

This model is also based on the assumption similar to that made in Walter‟s model. However, two additional assumptions made by this model are as follows: growth rate of the firm the firm „g‟ = br  The cost of capital is constant and is more than growth rate k > g  The

Gordon‟s Model 

Under this model, the market price of share is can be calculated as follows:

E(1-b) P= k–g The profit which is not distributed to the owners and kept in the business is known as retained earning