this presentation is on dividend policy and theories of dividend policy

1. Presented by
Dharmender kumar

2.  Dividend Policy refers to the explicit or implicit decision of
the Board of Directors regarding the amount of residual
earnings (past or present) that should be distributed to
the shareholders of the corporation.
• This decision is considered a financing decision because
the profits of the corporation are an important source of
financing available to the firm.

3.  Firm has 2 choices
• Pay dividend
• Reinvest funds instead of paying out

4. • In the absence of dividends, corporate earnings accrue to the benefit of
shareholders as retained earnings and are automatically reinvested in
the firm.
• When a cash dividend is declared, those funds leave the firm
permanently and irreversibly.
• Distribution of earnings as dividends may starve the company of funds
required for growth and expansion, and this may cause the firm to seek
additional external capital.
Retained Earnings
Corporate Profits After Tax
Dividends

5.  There is no legal obligation for firms to pay dividends to
common shareholders
 Shareholders cannot force a Board of Directors to
declare a dividend, and courts will not interfere with the
BOD’s right to make the dividend decision.

6.  THEORY OF IRRELEVANCE
1. Residual approach
2. Miller and Modgilani approach
 THEORY OF RELEVANCE
 1. Walter’s approach
 2. Gorden approach

7.  Dividend irrelevance theory is one of the
major theories concerning dividend policy
in an enterprise. It was first developed by
Franco Modigliani and Merton Miller in a
famous seminal paper in1961.
 The authors claimed that neither the price
of firm's stock nor its cost of capital are
affected by its dividend policy.
 This theory contain two theories.

8.  According to M-M, under a perfect market
situation, the dividend policy of a firm is
irrelevant, as it does not affect the value of
the firm.

9. Dividend
received at
the end of the
year
D1 P1 Market price
P0 of share at the
(1 Ke ) end of year
Market price
of the share at
the beginning Cost of equity
of period

10. Market price Dividend
of the share at received at
the beginning the end of the
of period year
P1 P 0(1 ke) D1
Market price
of share at the Cost of equity
end of year

11. Market total earning
Investment of the firm Number of
require shares which
Dividend
received at
the end of the
year
I ( E nD1)
m
P1
Number of shares Market price
outstanding at the of share at the
beginning of the end of year
period

12. Investment
Market price
require Market total
Value of the of share at the
earning of the
firm end of year
firm
(n m) P1 ( I E )
mP0 Cost of
(1 Ke ) equity
Number of Number of shares
share issue outstanding at the beginning
of the period

13.  There is perfect capital market
 investor are rational
 Information about company is freely
available
 there is no transaction cost
 No investor is large enough to effect
 there are no taxes

14. o According to relevant theory payment of dividend
affect the firm's stock and its cost of capital. this
theory is based on rate of interest and cost of capital.

15.  Walter'smodel supports the principle that
dividends are relevant. The investment policy of
a firm cannot be separated from its dividend
policy and both are inter-related. The choice of
an appropriate dividend policy affects the value
of an enterprise.

16. Price of equity dividend
D
P Expected
Ke g growth rate of
earning
dividend
Cost of equity

17. market price
per share
Earning per
share
r ( E D) / ke
P D
Ke
Internal rate of Cost of equity
return capital

18.  The investment of the firm are financed
through internal financing or retain earning
only.
 Rate of interest and cost of equity are
constant.
 Earning & dividend don’t change while
determining the value of the firm.
 Firm has very long life.

19. If r>k than firm retain the whole income
If r<k than firm can pay 100% dividend
 r = rate of interest
 k = cost of equity

20.  When r > ke, the value of shares is inversely related to
the D/P ratio. As the D/P ratio increases, the market
value of shares decline. It’s value is the highest when
D/P ratio is 0. So, if the firm retains its earnings
entirely, it will maximize the market value of the shares.
The optimum payout ratio is zero.
 When r < ke, the D/P ratio and the value of shares are
positively correlated. As the D/P ratio increases, the
market price of the shares also increases. The
optimum payout ratio is 100%.
 When r = ke, the market value of shares is constant
irrespective of the D/P ratio. In this case, there is no
optimum D/P ratio.

21.  A model for determining the intrinsic value of a stock,
based on a future series of dividends that grow at a
constant rate. Given a dividend per share that is payable
in one year, and the assumption that the dividend grows
at a constant rate in perpetuity, the model solves for the
present value of the infinite series of future dividends.
 Gordon's theory contends that dividends are relevant.
This model is of the view that dividend policy of a firm
affects its value.
 According to Gordon, the market value of a share is
equal to the present value of the future streams of
dividends means (ke = g)

22. D
P
Ke g
Where:
D = Expected dividend per share one year
from now
k = Required rate of return for equity
investor
G = Growth rate in dividends (in perpetuity)

23. Assumptions of this model
 The firm is an all equity firm. No external financing is
used and investment programmes are financed
exclusively by retained earnings.
 Return on investment( r ) and Cost of equity(Ke) are
constant.
 The firm has perpetual life.
 The retention ratio, once decided upon, is constant.
Thus, the growth rate, (g ) is also constant.
 Ke > g

24. THANKS