Dividend Policy -B.V.Raghunandan
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Dividend Policy -B.V.Raghunandan

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liberal and conservative dividend policies and theories of dividend policies for valuation of shares

liberal and conservative dividend policies and theories of dividend policies for valuation of shares

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Dividend Policy -B.V.Raghunandan Dividend Policy -B.V.Raghunandan Presentation Transcript

  • Chapter X
    Dividend Policies
  • Dividend
    The return given to the shareholders on their investment
    First Stage in Dividend Policy: Conservative
    Second Stage: Liberal
    Third Stage: No Dividend Policy
    India is in the second stage right now
  • Factors Determining Dividend Policy
    Company Policy
    Stability in Earnings
    Liquidity of the Co.
    Past Dividend Rates
    Projects under Consideration
    Market Expectation
    Taxation
    Legal restriction
    Independent Opportunities
    Restrictions of FIs
    Nature of Business
    Cost of Capital
    Phase of Trade Cycle
    Accumulated Reserves
    Co’s Growth Needs
    Bonus Issue
  • Types of Dividend Policies
    Conservative Dividend Policy
    Liberal Dividend Policy
  • Conservative Dividend Policy: Merits
    Good Treasury Mgt.
    Stability in Dividend
    Provision for Contingency
    Organic Growth
    Inorganic Growth
    Modest Expectation
    Taxation
    Higher Book Value
    Value Unlocking
    Research Oriented Companies
  • Demerits of Conservative Dividend Policy
    Lesser Image as a Creator of value for the Shareholders
    Book Value will be far more than Market Value of the Shares
    Accessing Capital Market becomes Difficult in the Future
    Lesser Liquidity for the Shares
  • Liberal Dividend Policy
    Handsome Dividend
    A Number of Interim Dividends within a Year
    Regular Issue of Bonus Shares
    Special dividends on Important Occasions
    Taking Care of Enhancing Shareholder Value as much as maximising Profits of the Company
  • Merits of Liberal Dividend Policy
    Good Image
    Shareholder Satisfaction
    Liquidity of the Scrip
    High Market Price
    Growth Driven Policy
    Accessing the Market
    Raising Finance Globally
    Constant Innovation
  • Demerits of Liberal Dividend Policy
    Difficult Treasury Management
    Lack of Stability in Dividend Payment
    Affecting Growth Prospects
    Insatiable Appetite of Shareholders
    High Dividend Tax
  • Bonus Shares
    Stock Dividend
    Capitalising the Reserves
    Given as a ratio 1:2
    Conserves Cash
    For the Shareholder, tax liability is less as stock dividend is not treated as income
  • Benefits of Bonus Shares to the Company
    No cash Outflow
    Higher Liquidity
    Good Image
    Higher Market Capitalisation
    Reduction in Rate of Dividend
    No Dividend Tax
    Undercapitalisation
  • Benefits of Bonus Shares to the Shareholders
    Higher Holding
    Partial Liquidation
    Taxability
    Higher Liquidity
    Higher Future Dividend
  • Impact of Bonus Shares
    On Balance Sheet: Asset side not affected, Reserves come down and Share Capital goes up-Net worth does not change
    On Share Price: Immediate high, subsequent lower and higher in the long term
    On EPS: Gets reduced- Suggestible when the operating profit is expected to go up
  • Bonus Shares & SEBI Guidelines
    Provision in Articles of Association
    Increasing Authorised Capital
    Out of Free Reserves/Share Premium
    Not Out of revaluation Reserve
    Only on Fully Paid Shares
    Not in Lieu of Dividend
    Implementation within six months
    No Default on Financial Obligations
    Not in one year of Public Issue/Rights Issue
    Applicable to Listed Companies
  • Dividend Models
    Walter’s Model
    Gordon’s Model
    Modigliani-Miller Model
  • Walter’s Model
    James Walter & his Article, ”Dividend Policy: Its Influence on the value of the Firm”
    Growth Firm: ROI > k-optimal dividend is 0%
    Normal Firm: ROI =k, Any rate of dividend
    Declining Firm: ROI < k , 100% Pay-Out Ratio
  • Assumptions of Walter’s Model
    Only Two Sources of Finance: Equity Shares and Retained Earnings
    ROI is constant from one year to another
    K is constant from one year to another
    Firm has an infinite life
  • Computation of Market Value of Shares
    Where
    P=Market Price of Equity
    R=Rate of Return
    K=cost of capital
    E=Earnings per Share
    D=Dividend per Share
  • Problem No. 1
    The National Sports Company with an EPS of Rs.11 and a cost of capital at 13%, achieved a Return on Investment at 18%. As per Walter’s Model, what would be the optimum pay-out ratio? What would be the share price at this ratio?
  • Problem No.2
    The earning per share of a company are Rs.8.It has an internal rate of return of 14% and the capitalisation of its risk class is 12%. If Walter’s Model is used,
    What should be the optimum pay-out ratio of the firm?
    What would be the price of its share at this pay-out ratio?
    How shall the price of the share be affected, if 20% pay-out ratio was employed?
  • Percentage of Dividend & Dividend Pay-Out Ratio
    If Dividend is given as a percentage, it should be calculated on the face value.
    If it is given as a pay-out ratio, it should be calculated on the EPS
  • Problem No.3
    Company A has achieved an EPS of Rs.8 for the year2007-08. What is the Dividend per Share if,
    (a) 25% dividend is declared on the share of Rs.10 face value
    (b) dividend pay-out ratio is 25%
  • Problem No.4
    Fairever Cosmetics achieved an EPS of Rs.9 per share on its equity share of Rs.10 each., for the year 2006-07.It achieved a Return on Investment @ 14% with a cost of capital @ 16%. What is the ideal pay-out ratio?
    At that ratio, calculate the market value of share of the firm.
    If Board of Directors recommend a Dividend of Rs.4, what would be the market price of share of the firm?
  • Problem No.5
    For the year 2006-07, Sellwell Ltd., achieved an EPS of Rs.9. Its cost of capital is 11% and Rate of Return is 14%.
    Determine its market price when the dividend pay-out ratio is (a) o% (b) 25% © 50% (d) 100%
  • Problem No. 6
    Trywell Ltd., achieved an EPS of Rs.12 on its equity shares of Rs.10. The cost of capital of the company was 7% while the rate of return was 4%.
    Calculate the market price of the share if the Dividend Pay-out ratio was (a) 0% (b) 20% © 40% (d) 80% (e) 100%
  • Problem No.7
    Consider the following data:
    Growth Normal Declining
    Firm FirmFirm
    ROI 17% 18% 19%
    K 15% 18% 20%
    EPS (Rs) 6 6 6
    Calculate the market price of shares of the
    firms if the pay-out ratio is 20%, 45% or 70%.
    Also comment on it.
  • Criticisms of Walter’s Model
    Only zero debt companies have equity and retained earnings as the only two sources of finance
    ROI will not be constant
    K also will not remain constant
  • Dividend Capitalisation Model
    Myron J. Gordon concurred with Walter in Dividend being relevant to Market price of Share
    He differed in advocating growth as the driver of the market price
    Growth is the product of retention ratio (b) and Rate of Return (R)
  • Assumptions of Gordon’s Model
    Only Equity and Retained Earnings are the only sources of finance
    R is constant from one year to another
    Taxes do not exist
    K is also constant
    The Firm has a perpetual life
  • Computation of Market Price
  • Miller-Modigliani Dividend Model
    Merton Miller & Franco Modigliani presented a paper in 1958 and argued that Dividend
    was irrelevant in determining the price of the share
    • It was the Investment policy and earnings of the firm that determined the share price
    • In 1961, an Article was published by them, which came to be known as Irrelevance Theory
  • Arbitrage Process
    Price may go up post declaration of dividend
    After the payment of dividend, the firm may have to access the capital market for the future requirement
    This will bring down the price of the shares to the previous levels
    The Theory impacted the capital market so much that nearly 70% of American Corporations became ‘No Dividend’ Corporations
  • Assumptions
    Perfect Capital Markets:
    - all the investors are rational
    -price sensitive information is available to all
    the investors simultaneously
    -securities are infinitely divisible
    - no single investor is big enough to
    influence the price
    2. Non-Existence of Taxes
    3. Constant Investment Policy
    4. Forecasting Ability
  • Computation of Share Price
    Where
    Po = Price at the beginning
    P1 = Price at the end
    ke = Cost of Equity
    D = Dividend per Share
  • Exercise-page No.289
    17. The share price of TVS Electronics Ltd. was ruling at Rs. 57.60. The Board of Directors declared a dividend of Re. 0.70 per share of Rs. 10. If cost of equity is 3%, calculate the share price after declaration of dividend using Miller Modigliani Dividend Model.
  • Exercise-Page No.289
    16. Cost of Equity of VIP Industries Ltd. was 5% and the price of equity share was Rs. 122.60. The company declared a dividend at 20% on its equity shares having the face value at Rs. 10. What will be the share price after the declaration of dividend? 
    18. Triumph Engineering Ltd had 5,000 equity shares of Rs. 100 each. During a financial year, its cost of equity was 17%%. Using Miller - Modigliani model, decide what will be the price of the share, if no dividend is declared? If a dividend of Rs. 23 per share is declared, what will be the share price?
  • Exercise-Page No.289
    19. United Pharma Ltd. had 3,00,000 outstanding equity shares of Rs.10 each on Jan 1,2007. The company now intends to pay Rs.6 per share for the current year. It belongs to a risk class whose appropriate capitalisation rate is 9%. Determine the price of the company’s share using Modigliani-Miller model,
    (i) when dividend is declared
    (ii) when no dividend is declared.
    19. United Pharma Ltd. had 3,00,000 outstanding equity shares of Rs.10 each on Jan 1,2007. The company now intends to pay Rs.6 per share for the current year. It belongs to a risk class whose appropriate capitalisation rate is 9%. Determine the price of the company’s share using Modigliani-Miller model,
    (i) when dividend is declared
    (ii) when no dividend is declared.
    19. United Pharma Ltd. had 3,00,000 outstanding equity shares of Rs.10 each on Jan 1,2007. The company now intends to pay Rs.6 per share for the current year. It belongs to a risk class whose appropriate capitalisation rate is 9%. Determine the price of the company’s share using Modigliani-Miller model,
    (i) when dividend is declared
    (ii) when no dividend is declared.
  • Exercise-Page No.292
    17. Two chemical companies A Ltd. and B Ltd. had equity shares priced at Rs. 300 each. During the financial year 2006-07, each one made a net profit of Rs. 430 crores. Cost of equity is the same for both the companies at 16%. A Ltd. decided to declare a dividend at Rs. 7 per share and B Ltd. decided not to declare any dividend.
    Using Miller-Modigliani hypothesis,
    a) Calculate the share price of A Ltd. after dividend declaration
    b) Calculate the share price of BLtd. after the results
    c) Is there any difference in the total shareholder wealth between the two companies?
  • Exercise-Page No 292
    16. The following seven engineering companies undertake turn-key projects in India. Their financials for 2004-05 are given below. All the companies have Rs. 10 as the Face value of share of a Company
    P0 D ke (%)
    ABG Heavy Industries Ltd 264 1.50 4.4
    Engineers India Ltd 823 7.50 2.4
    Hindustan Dorr-Oliver Ltd 813 1.20 2.2
    MC. NallyBharath Ltd 130 0.30 2.3
    Petronet Engineering Ltd 168 1.00 5.9
    PSL Ltd 251 4.50 4.14
    Sanghvi Motors Ltd. 840 5.00 2.1
    Using Modigliani - Miller hypothesis, calculate the market price of shares after the declaration of dividend.
     
  • Exercise-page No.292
    18. Apply Modigliani - Miller hypothesis and determine the share prices of the following companies after the declaration of dividend.
    Problem No. 19
  • THANK YOU