1. A dividend is a distribution of a company's earnings to shareholders that is decided by the board of directors and indicates a company's positive future and strong performance.
2. There are several types of dividends including cash dividends, which are the most common and paid in cash; bonus shares which are additional shares given to shareholders; and share repurchases where a company buys back its own shares.
3. Several theories provide frameworks for determining optimal dividend policies including Walter's model which shows the relationship between a firm's internal rate of return and cost of capital, Gordon's model which relates market value to dividends, and Modigliani and Miller's hypothesis that dividend policy does not impact share
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Dividend Definition Types Theories Working Capital
1. DEFINITION OF DIVIDEND
A dividend is a distribution of part of the earnings of the company to its equity shareholders.The board of directors
of the company decides the dividend amount to be paid out to the shareholders. Through a distribution from their
earnings, companies indicate a positive future and a strong performance. The ability and the willingness of a
company to pay stable dividends over a good period of time.
CASH DIVIDEND: A Cash dividend is the most common form of the dividend. The shareholders are paid in cash
per share. The board of directors announces the dividend payment on the date of declaration. But for distributing
cash dividend, the company needs to have positive retained earnings and enough cash for the payment of dividends.
BONUS SHARE: Bonus share is also called as the stock dividend. Bonus shares are issued by the company when
they have low operating cash,but still want to keep the investors happy.Each equity shareholderreceives a certain
number of additional shares depending on the number of shares originally owned by the shareholder.
For example, if a person possesses10 shares of Company A, and the company declares bonus share issue of 1 for
every 2 shares,the person will get 5 additional shares in his account.From company’s angle, the no. of shares and
issued capital in the company will increase by 50% (1/2 shares).The market price, EPS, DPS etc will be adjusted
accordingly.
SHARE REPURCHASE: Share repurchase occurs when a company buys back its own shares from the market and
reduces the number of shares outstanding.This is considered as an alternative to the dividend payment as cash is
returned to the investors through anotherway.
PROPERTY DIVIDEND: The company makes the payment in the form of assets in the property dividend. The
asset could be any of this equipment, inventory, vehicle or any other asset.The value of the asset has to be restated
at the fair value while issuing a property dividend.
SCRIP DIVIDEND: Scrip dividend is a promissory note to pay the shareholders later. This type of dividend is used
when the company does not have sufficient funds for the issuance of dividends.
THEORIES OF DIVIDEND POLICY
Professor James E. Walterargues that the choice of dividend policies almost always affects the value of the
enterprise. His model shows clearly the importance of the relationship between the firm’s internal rate of return (r)
and its cost of capital (k) in determining the dividend policy that will maximise the wealth of shareholders.
Walter’s model is based on the following assumptions:
1. The firm finances all investment through retained earnings; that is debt or new equity is not issued;
2. The firm’s internal rate of return (r), and its cost of capital (k) are constant;
2. 3. All earnings are either distributed as dividend or reinvested internally immediately.
4. Beginning earnings and dividends never change.The values of the earnings pershare (E), and the divided per
share (D) may be changed .
5. The firm has a very long or infinite life.
Walter’s formula to determine the market price per share (P) is as follows:
P = D/K +r(E-D)/K/K
2. Gordon’s Model:
One very popular model explicitly relating the market value of the firm to dividend policy is developed by Myron
Gordon.
Assumptions:
Gordon’s model is based on the following assumptions.
1. The firm is an all Equity firm
2. No external financing is available
3. The internal rate of return (r) of the firm is constant.
4. The appropriate discount rate (K) of the firm remains constant.
5. The firm and its stream of earnings are perpetual
6. The corporate taxes do not exist.
7. The retention ratio once decided upon, is constant.Thus,the growth rate (g) = br is constant forever.
3. Modigliani and Miller’s hypothesis:
According to Modigliani and Miller (M-M), dividend policy of a firm is irrelevant as it does not affect the wealth of
the shareholders.They argue that the value of the firm depends on the firm’s earnings which result from its
investment policy.
Assumptions.
1. The firm operates in perfect capital market
2. Taxes do not exist
3. The firm has a fixed investment policy
4. Risk of uncertainty does not exist. That is, investors are able to forecast future prices and dividends with certainty
and one discount rate is appropriate for all securities and all time periods. Thus,r = K = Kt for all t.
Under M – M assumptions,r will be equal to the discount rate and identical for all shares.
Determinants of Dividend Policy are: (i) Type of Industry (ii) Age of Corporation (iii) Extent of share distribution
(iv) Need for additional Capital (v) Business Cycles (vi) Changes in Government Policies (vii) Trends of profits (vii)
Trends of profits (viii) Taxation policy (ix) Future Requirements and (x) Cash Balance.
Age of Corporation: Newly established enterprises require most of their earning for plant improvement and
expansion, while old companies which have attained a longer earning experience, can formulate clear cut dividend
policies and may even be liberal in the distribution of dividends.
Business Cycles: During the boom, prudent corporate management creates good reserves for facing the crisis which
follows the inflationary period. Higher rates of dividend are used as a tool for marketing the securities in an
otherwise depressed market.
3. Changes in Government Policies: Sometimes government limits the rate of dividend declared by companies in a
particular industry. The Government put temporary restrictions on payment of dividends by companies in July 1974
by making amendment in the Indian Companies Act, 1956. The restrictions were removed in 1975.
Trends of profits: The past trend of the company’s profit should be thoroughly examined to find out the average
earning position of the company. The average earnings should be subjected to the trends of general economic
conditions.If depression is approaching, only a conservative dividend policy can be regarded as prudent(showing
care).
Taxation policy: Corporate taxes affect dividends directly and indirectly directly, in as much as they reduce the
residual profits after tax available for shareholders and indirectly, as the distribution of dividends beyond a certain
limit is itself subject to tax. At present,the amount of dividend declared is tax free in the hands of shareholders.
Cash Balance: If the working capital of the company is small liberal policy of cash dividend cannot be adopted.
Dividend has to take the form of bonus shares issued to the members in lieu(instead) of cash payment.
WORKING CAPITAL- In an ordinary sense,working capital denotes the amount of funds needed for meeting day-
to-day operations of a concern.This is related to short-term assets and short-termsources of financing.
Concept of Working Capital:
The funds invested in current assets are termed as working capital. It is the fund that is needed to run the day -to-day
operations. Generally, working capital refers to the current assets ofa company that are changed from one form to
anotherin the ordinary course of business,i.e. from cash to inventory, inventory to work in progress (WIP), WIP to
finished goods,finished goods to receivables and from receivables to cash.
Gross Working Capital:
The sum total of all current assets ofa business concern is termed as gross working capital. So,Gross working
capital = Stock + Debtors + Receivables + Cash.
Net Working Capital:
The difference between current assets and current liabilities of a business concern is termed as the Net working
capital. Hence, Net Working Capital = Stock + Debtors + Receivables + Cash – Creditors – Payables.
Nature of Working Capital:
i. It is used for purchase of raw materials, payment of wages and expenses.
ii. It changes form constantly to keep the wheels of business moving.
iii. Working capital enhances liquidity, solvency,creditworthiness and reputation of the enterprise.
iv. It generates the elements of cost namely: Materials, wages and expenses.
v. It enables the enterprise to avail(take advantage)the cash discount facilities offered by its suppliers.
vi. It helps improve the morale of business executives and their efficiency reaches at the highest climax.
Classification of Working Capital:
4. (a) Gross Working Capital: Gross working capital refers to the amount of funds invested in various components
of current assets.It consists ofraw materials, work in progress,debtors,finished goods,etc.
(b) Net Working Capital: The excess of current assets overcurrent liabilities is known as Net working capital. The
principal objective here is to learn the composition and magnitude of current assets required to meet current
liabilities.
(c) Positive Working Capital: This refers to the surplus of current assets overcurrent liabilities.
(d) Negative Working Capital: Negative working capital refers to the excess of current liabilities over current
assets.
(e) Permanent Working Capital: The minimum amount of working capital which even required during the dullest
season ofthe year is known as Permanent working capital.
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