dividend - DIVIDEND DECISIONS Dividend refers to the...

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Unformatted text preview: DIVIDEND DECISIONS Dividend refers to the business concerns net profits distributed among the shareholders TYPES OF DIVIDEND Cash dividend Stock dividend Bond dividend Property dividend Cash Dividend If the dividend is paid in the form of cash to the shareholders. Stock Dividend Stock dividend is paid in the form of the company stock due to raising of more finance. Cash is retained by the business concern. Stock dividend may be bonus issue. This issue is given only to the existing shareholders of the business concern. Bonus shares Increases the paid up capital and Reduces retention of earnings. (does not affect the wealth of shareholders Eps and Mp will fall) Why? Issue bonus shares Bonus – shares- Bonus shares Converting free reserves in to Equity Free reserves Equity capital Reasons for issue of bonus shares To bring down the MP of a share To Promote active trading of shares To achieve Respectable size in the eyes of investors To send signals that company future projects have brightened- future dividends will inrease Bond Dividend also called as scrip dividend. If the company does not have sufficient funds to pay cash dividend, the company promises to pay the shareholder at a future specific date with the help of issue of bond or notes. Property Dividend Property dividends are paid in the form of some assets other than cash. DIVIDEND POLICY It is the policy of a firm in distributing net earnings to its equity shareholders. Dividend policy depends upon the nature of the firm, type of shareholder and profitable position. So, dividend policy really involves 2 decisions: How much of the firm’s earnings should be distributed to shareholders as dividends, and How much should be retained for capital investment. TYPES OF DIVIDEND POLICIES Regular dividend policy Stable dividend policy Irregular dividend policy No dividend policy. Regular Dividend Policy Dividend payable at the usual rate is called as regular dividend policy. Suitable to the small investors, retired persons and others. Stable Dividend Policy Payment of certain minimum amount of dividend regularly. Three forms Constant Dividend per share ( pays fixed amount per share as dividend) Constant payout ratio (dividend payout ratio = Dividend/Earnings) (Constant percentage of net earnings is paid) Stable rupee dividend plus extra dividend. (Minimum dividend per share + Extra dividend is paid in the years of Prosperity) Irregular Dividend Policy When the companies are facing constraints of earnings and unsuccessful business operation, they may follow irregular dividend policy. It is one of the temporary arrangements to meet the financial problems. No Dividend Policy Sometimes the company may follow no dividend policy because of its unfavourable working capital position of the amount required for future growth of the concerns FACTORS DETERMINING DIVIDEND POLICY Nature of Earnings Age of Company Liquidity Position of the company Equity shareholders Preferences Legal Requirments Dividends cannot be declared out of capital. (Capital Impairment Rule) Insolvency rule (L>A)( the firms inability to pay to its creditors. (to protect the creditors) Access to capital Market Control objective Jan.4 Jan.28 Feb.1 Mar. 11 Declare Ex-div. Record dividend date date Payment date Dividend Payments 1) Declaration Date: the board of directors declares the dividend, determines the amount of the dividend, and decides on the payment date. Jan.4 Jan.28 Feb.1 Mar. 11 Declare Ex-div. Record dividend date date Payment date Dividend Payments 2) Ex-Dividend Date: Jan.4 Jan.28 Feb.1 Mar. 11 Declare Ex-div. Record dividend date date Payment date Dividend Payments 2) Ex-Dividend Date: To receive the dividend, you have to buy the stock before the ex-dividend date. On this date, the stock begins trading “ex-dividend” and the stock price falls approximately by the amount of the dividend. Jan.4 Jan.28 Feb.1 Mar. 11 Declare Ex-div. Record dividend date date Payment date Dividend Payments 3) Date of Record: Jan.4 Jan.28 Feb.1 Mar. 11 Declare Ex-div. Record dividend date date Payment date Dividend Payments 3) Date of Record: 4 days after the exdividend date, the firm receives the list of stockholders eligible for the dividend. often, a bank acts as registrar and maintains this list for the firm. Jan.4 Jan.28 Feb.1 Mar. 11 Declare Ex-div. Record dividend date date Payment date Dividend Payments 4) Payment Date: date on which the firm mails the dividend checks to the shareholders of record. RELEVANCE THEORIES OF DIVIDEND Dividend Decision affects the value of firm. High Dividend Payout ratio - market price = W(S) Low Dividend Payout ratio - Market price = W(S) Supported by two eminent persons like Walter and Gordon. Walter’s Model Prof. James E. Walter argues that the dividend policy almost always affects the value of the firm. Based on two important factors: • Rate of return (r) • Cost of capital (k) Walter’s model, r>k Profitable firm More investment opportunities Growth firm Retain the earnings Share Price Maximise r<k Declining Firm No investment opportunities Distribute Dividend Payout ratio the earnings =100% as dividends r=k Normal Firm Distribute/ retain a certain % of earnings as dividends Less investment opportunities the firm is earning more than what shareholders could earn by investing else where Dividend pay out ratio = zero Dividend Payout ratio = 0 to 100% Optimal Dividend Payoutratio Criticism of Walter’s Model There is no possibility of constant return. Walter model, it is based on constant cost of capital. But it is not applicable in the real life of the business. Gordon’s Model suggest one of the popular model which assume that dividend policy of a firm affects its value, and Criticism of Gordon’s Model There is no debt and equity finance used by the firm. It is not applicable to present day business. Ke and r cannot be constant in the real practice. According to Gordon’s model, there are no tax paid by the firm. It is not practically applicable. Irrelevance of Dividend According to professors Solomon, Modigliani and Miller, Dividend policy has no effect on the share price of the company. There is no relation between the dividend rate and value of the firm. Dividend decision is irrelevant of the value of the firm. Assumptions of MM hypothesis ☻There are perfect capital market. ☻Investors behave rationally. ☻Info about the company is available to all without any cost. ☻There are no flotation or transaction cost. ☻No investor is large enough to effect the market price of share. ☻The firm has rigid investment policy. ☻There are either no tax or no difference in tax rates applicable to dividend and capital gain. ☻There is no risk or uncertainties The argument of MM The argument given by MM in support of their hypothesis is that whatever increase in the value of the firm results from the payment of dividend, will be exactly offset by the decline in market price of shares because of external financing and there will be no change in the total wealth of shareholders. Po=D1+P1/1+Ke Po= Market price per share at the beginning of the period D1= Dividend to be received at the end of the period ...
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  • Spring '17
  • Dividend, Dividend yield, Prof. James E. Walter

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