Point 2 : r decreases as more and more investment is made. This reflects the assumption that the most profitable investments are made and then the poorer investments are made.3-> it changes directly with the risk. Thus, the present value of the firm’s income moves inversely with the cost of capital. By assuming that the discount rate, k, is constant, Walter's model abstracts from the effect of risk on the value of the firm
Transcript of "Dividend Policy of Sensex Companies using Walter's Model"
To Study the Dividend Policy Of Sensex Companies using Walters Model
The dividend policy of a company determines what proportion of earnings is distributed to the shareholders by way of dividends, and what proportion is ploughed back for reinvestment purposes. Since the main objective of financial management is to maximise the market value of equity shares, one key area of study is the relationship between the dividend policy and market price of equity shares. According to Walter’s Model , the dividend policy of a firm depends upon the relationship between r(rate of return) & k(cost of capital). If r>k (a case of a growth firm), the firm should have zero payout and reinvest the entire profits to earn more than the investors. If however, r<k, then the firm should have 100% payout ratio and let the shareholders reinvest their dividend income to earn higher returns, if ‘r’ happens to be just equal to ke, the shareholders will be indifferent whether the firm pays dividends or retain the profits. In such a case, the returns of the firm from reinvesting the retained earnings will be just equal to the earnings available to the shareholders on their investment of dividend income.
The Walter’s model provides a theoretical and simple frame work to explain the relationship between policy and value of the firm. As far as the assumptions underlying the model hold well, the behaviour of the market price of the share in response to the dividend policy of the firm can be explained with the help of this model. The limitation of this model is that these underlying assumptions are too unrealistic. The financing of investments proposals only by retaining earnings and no external financing is seldom found in real life. The assumption of constant ‘r’ and constant ‘ke’ is also unrealistic and does not hold good. As more and more investment is made, the risk complexion of the firm will change and consequently the ke may not remain constant.
Dividend refers to the corporate net profits distributed among shareholders. Dividend Policy refers to the explicit or implicit decision of the Board of Directors regarding the amount of residual earnings 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.
The optimal dividend policy of a firm depends on investor’s desire for capital gains as opposed to income their willingness to forgo dividend now for future returns perception of the risk associated with postponement of returns. -Various firms adopt dividend policies depending on the company’s articles of association and the prevailing economic situation. -Some make high pay out, while others make low pay out -Yet others pay stock dividends (bonus issue) in lieu of or in addition to cash dividend - While others pay cash only.
Walter’s model supports the doctrine that dividends are relevant. The investment policy of a firm cannot be separated from its dividends policy and both are, according to Walter, interlinked. The choice of an appropriate dividend policy affects the value of an enterprise.
All financing is done through retained earnings: external sources of funds like debt or new equity capital are not used. With additional investments undertaken, the firm’s business risk does not change. It implies that r and k are constant. There is no change in the key variables, namely, beginning earnings per share, E, and dividends per share, D. The values of D and E may be changed in the model to determine results, but, any given value of E and D are assumed to remain constant in determining a given value. The firm has perpetual (or very long) life.
r D E D keke P r D E D keP kewhereP The prevailing market price of a shareD Dividend per shareE Earnings per sharer The rate of return on the firms investment
Sr. Name of the Topic Author Brief about the PaperNo Paper1. Effects of Rabindra 1.There is a significant effect of dividend policy Dividends on Joshi on stock prices of the companies in both banking Stock Prices and non-banking sector. in Nepal 2.Walters model has 4 basic assumptions : a.Retained earnings are only source of finance available for a firm. b.Cost of capital and Rate of Returns are assumed to be constant and thus any additional investments made by firm will not change its risk profile. c.Firm has infinite life. d.DPS and EPS for a given value of the firm, remains constant 3.The Walters model explains the three possibilities : a.rate of return = cost of equity ->the dividend policy is irrelevant in deciding the value of the firm. b.rate of return < cost of equity -> 100% payout helps in increasing value of the firm. c.rate of return = cost of equity -> the firm can retain the earnings for further investments 4.According to various researches conducted by taking the stock prices if the companies as dependent variable and dividends per share,retained earnings per share,market price per share as dependent variable, it was found that dividends have a significant effect on the stock prices and the value of the firm. 5.Generally, people who come below the income tax range are interested in higher dividends whereas those with higher incomes prefer low dividends for tax purposes. 6.The retained earnings are not taxed until the earnings are realized.The shareholders enjoy tax advantage in retained earnings.
Sr Name Topic Author SummaryNo. The Level Of To Study Bitok Kibet, Moi The objective of this study was to Corporate Dividend University, Kenya determine the level of corporate Dividend Pay Policy of Tenai Joel, Moi dividend payout to stockholders and out to Sensex University, Kenya establish if the optimal dividend Stockholders: Companies Cheruiyot policy exists for the firms quoted at Does Optimal using Walters Thomas, Moi the Nairobi Stock Exchange. Dividend Policy Model. University, Kenya The dividend model provides a Exist For Firms Maru Loice, Moi summary of the factors that Quoted University, Kenya influenced and continue to influence At The Nairobi Kipsat Mary, Moi the dividend decisions for this market Stock University, Kenya. including and not limited to the tax Exchange? systems, clientele preferences, signaling, sustainability, low liquidity, high growth, ownership control and dividends as residual etc. From the model it is possible to predict the likely dividend decisions of the firms in future.
Sr Name Topic Author SummaryNo. Dividend Policy: To Study Husam-Aldin This paper aims at providing the reader A Review of Dividend Nizar Al- with a comprehensive Theories and Policy of Malkawi, understanding of dividends and dividend Empirical Sensex Michael policy by reviewing the main theories and Evidence. Companies Rafferty, explanations. using Walters Rekha Pillai. The Basic Irrelevance Thesis Model. Bird-In-The-Hand Hypothesis Tax-EffectHypothesis This paper began with an overview of the evolution of corporate dividend policy. It was noted that dividend policy has been bound up with the development and history of the corporation itself. The paper also presented the basic argument and M&M proof of dividend irrelevancy. The paper then explored the main theories that counter the irrelevancy proposition. In order to provide an understanding of dividend policy theories, attempted to explain the basic argument for each theory followed by the most important empirical evidence on testing of these theories.
Sr. Name of the Topic Author Brief about the PaperNo Paper1 THE EFFECT To study Dr. J. J. -The objective of this research paper is to examine the OF DIVIDEND the dividend Adefila possible effects that a firm’s POLICY ON dividend policy might have on the market price of its policy of THE MARKET common stock and also, those factors that influence Sensex firm’s dividend policy in general. PRICE OF Companies - The objective of the firm is to increase the wealth of SHARES IN using its stockholders. Hence the best dividend policy is the NIGERIA: one that increases shareholders wealth by the greatest CASE STUDY Walters amount. OF FIFTEEN model. - Walters Model is a strategy that is used to study the QUOTED Dividend policy of a company and its effect on the COMPANIES market share price. -It is based on : where the reinvestment rate, that is, rate of return that the company may earn on retained earnings, is higher than cost of equity then, it would be in the interest of the firm to retain the earnings. -If the company’s reinvestment rate on retained earnings is the less than shareholders’ rate of return, the company should not retain earnings. -If the two rates are the same, then the company should be indifferent between retaining and distributing.
We have taken the sample of the Sensex companies as oursample which includes 30 companies. We will be taking theMarket share price as the independent variable and the othervariables like dividend per share, earning per share and rateof return and independent variables. We will be analysing the effect of the Walter’s DividendPolicy on the share prices of these sensex companies. Data is obtained from : Money control Ace Equity Analyzer
EPS Rate of Return Cost of Capital Dividends Payout Ratio
EPS : Rs. 22.02 r=17.26% D1 = 215%(Face Value = 2 Rs) = Rs. 4.30 g = 10% Po =436.35 (Year 2011) Ke= 4.30/436.35 = 0.0098+0.10=.11 r>ke