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Dividend Decisions Shabareesh Reddy -117

Manoj Rokade -120 Sadhana Shas t r i -136

Sanke t Sawant -127Sambhav Shah-129

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MEANING

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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It refers to the policy that the management formulates in regard to earnings for distribution as dividends among shareholders. it determines the division of earnings between payments to shareholders and retained earnings.

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Double Tax• If the company decides to pay out dividends, the earnings are taxed twice by

the government because of the transfer of the money from the company to the shareholders. The first taxation occurs at the company's year-end when it must pay taxes on its earnings. The second taxation occurs when the shareholders receive the dividends, which come from the company's after-tax earnings.

• The shareholders pay taxes first as owners of a company that brings in earnings and then again as individuals, who must pay income taxes on their own personal dividend earnings.

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SIGNIFICANCE OF DIVIDEND POLICY The firm has to balance between the growth of the company and the

distribution to the shareholders.

It has a critical influence on the value of the firm.

It has to also to strike a balance between the long term financing decision (company distributing dividend in the absence of any investment opportunity) and the wealth maximization.

The market price gets affected if dividends paid are less.

Retained earnings helps the firm to concentrate on the growth, expansion and modernisation of the firm.

To sum up, it to a large extent affects the financial structure, flow of funds, corporate liquidity, stock prices, growth of the company and investor’s satisfaction.

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SIGNIFICANCE OF STABILITY OF DIVIDEND

• Confidence among shareholders.

• Investors desire for current income.

• Institutional investor’s requirement.

• Stability in market prices of shares.

• Raising additional finances.

• Spreading of ownership of outstanding shares.

• Reduces the chances of loss of control.

• Market for debentures and preference shares.

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FORMS OF DIVIDEND

• SCRIP DIVIDEND- An unusual type of dividend involving the distribution of promissory notes that call for some type of payment at a future date.

• BOND DIVIDEND- A type of liability dividend paid in the dividend payer's bonds.

• PROPERTY DIVIDEND- A stockholder dividend paid in a form other than cash, scrip, or the firm's own stock.

• CASH DIVIDEND- A dividend paid in cash to a company’s shareholders, normally out of the its current earnings or accumulated profits.

• BONUS SHARE OR STOCK DIVIDENDS- A dividend payment made in the form of additional shares, rather than a cash payout.

• OPTIONAL DIVIDEND- Dividend which the shareholders can choose to take as either cash or stock.

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Dividend Theories

Relevance Theories(i.e. which consider

dividend decision to be relevant as it affects the

value of the firm)

Walter’s Model

Gordon’s Model

Irrelevance Theories(i.e. which consider

dividend decision to be irrelevant as it does not affects the value of the

firm)

Modigliani and Miller’s Model

Traditional Approach

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RELEVANCE THEORIES

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WALTER’S MODEL

• Prof James E. Walter considers dividend as one of the important factors determining the market value of the firm.

Situation 1

Dividend paid to shareholder

Reinvested to get higher returns{cost of capital (Ke)}

Situation 2

Firm do not pay out dividends

Invest retained earnings in profitable opportunities to earn return (r)

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ASSUMPTIONS OF WALTER’S MODEL

Retained earning are only source of financing investment in firm

The cost of capital (Ke), and rate of return on investment (r ), are constant.

Firms life is endless

Give or not to give out dividend depends on the opportunities to invest retain earning.

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FORMULA OF WALTER’S MODEL

Where,

P = Current Market Price of equity share

E = Earning per share

D = Dividend per share

(E-D) = Retained earning per share

r = Rate of Return on firm’s investment or Internal Rate of Return

k = Cost of Equity Capital

P D + r (E-D)

k k

=

CRITICISMS OF WALTER’S MODEL

• Only Retained Earnings And No External Financing.

• R Is Constant.

• K Is Constant.

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GORDON’S MODEL•Myron Gordon consider dividends are relevant and the dividend decision of the company affects its value.

Investors are risk averse

Future capital gain to be more risky

Discount the future capital gain at a higher rate(ke>g)

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ASSUMPTIONS OF GORDON’S MODEL

The product of retention ratio and rate of return gives us growth of firm(b X r=g)

Cost of capital is greater then growth rate (k>br=g)

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FORMULA OF GORDON’S MODEL

Where,

P = Price

E = Earning per Share

b = Retention Ratio

k = Cost of Capital

br = g = Growth Rate

P = E (1 – b) K - br

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IRRELEVANCE THEORIES

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MODIGLIANI & MILLER’S IRRELEVANCE MODEL

Value of Firm (i.e. Wealth of Shareholders)

Firm’s Earnings

Firm’s Investment Policy and not on dividend policy

Depends on

Depends on

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M-M’s ASSUMPTIONS

Perfect capital market

No taxes

No floating cost

Firm has a fixed investment policy.

No risk or uncertainity

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M-M’s Argument• If a company retains earnings instead of giving it out as dividends,

the shareholder enjoy capital appreciation equal to the amount of earnings retained.

• If it distributes earnings by the way of dividends instead of retaining it, shareholder enjoys dividends equal in value to the amount by which his capital would have appreciated had the company chosen to retain its earning.

• Hence, the division of earnings between dividends and retained earnings is IRRELEVANT from the point of view of shareholders.

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CRITICISM OF M-M MODEL TAX DIFFERENTIAL

FLOATION COST

TRANSACTION COST

DISCOUNT RATE

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Dividend Summary of Reliance Ind.

Announcement Date

Effective Date

Dividend Type

Dividend (%)

17-04-15 08-05-15 Final 100.00

21-04-14 16-05-14 Final 95.00

16-04-13 10-05-13 Final 90.00

20-04-12 31-05-12 Final 85.00

21-04-11 05-05-11 Final 80.00

26-04-10 10-05-10 Final 70.00

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REFERENCES

http://www.articlesbase.com/college-and-university-articles/dividend-decision-5852765.html

http://www.efinancemanagement.com/dividend-decisions/walters-theory-on-dividend-policy

http://www.moneycontrol.com/company-facts/relianceindustries/dividends/RI

http://economictimes.indiatimes.com/reliance-capital-ltd/infocompanydividends/companyid-13189.cms\

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