The document discusses dividend decision and dividend policy. It defines dividends as profits distributed to shareholders. Dividend decision is made by company directors and impacts capital structure, stock price, and shareholder taxation. Determinants of dividend policy include payout ratio, stability, legal constraints, owners' needs, and capital market factors. Common dividend policies are regular, stable, and irregular. Dividends can be interim, proposed, final, unclaimed, etc. Various theories on the relationship between dividends and firm value are discussed, including whether dividends are relevant or irrelevant to value. Models by Walter, Gordon, and Miller-Modigliani are summarized.

1. DIVIDEND DECISION
&
DIVIDEND POLICY

2. INTRODUCTION
Definitions
Dividend
Dividend refers to the corporate net profits distributed among
shareholders. Dividends can be both preference dividends and
equity dividends. Preference dividends are fixed dividends paid
as a percentage every year to the preference shareholders if net
earnings are positive. After the payment of preference dividends,
the remaining net profits are paid or retained or both depending
upon the decision taken by the management.
Dividend Decision
It’s a decision made by the directors of a company. It relates to
the amount and timing of any cash payments made to the
company stockholders. The decision is an important one for the
firm as it may influence its capital structure and stock price. In
addition, it may determine the amount of taxation that
stockholders should pay.

3. DETERMINANTS OF
DIVIDEND POLICY.
 The main determinants of dividend policy
of a firm can be classified into:
 Dividend payout ratio
 Stability of dividends
 Legal, contractual and internal constraints
and restrictions
 Owner's considerations
 Capital market considerations and
 Inflation.

4. TYPES OF DIVIDEND
POLICY
 REGULAR DIVIDEND POLICY
 STABLE DIVIDEND POLICY
a. constant dividend per share
b. constant pay out ratio
c. stable rupee dividend plus extra
dividend
 IRREGULAR DIVIDEND
POLICY
 NO DIVIDEND POLICY

5. TYPES OF DIVIDENDS
1. Interim Dividend
2. Proposed Dividend
3. Final Dividend
4. Unclaimed Dividend
5. Liquid Dividend
6. Stock Dividend
7. Dividend in Asset Form

6. In order to better understand the relationship
between dividend policy and the value of the
firm, different theories have been advanced.
These theories can be grouped into two
categories:
a. Theories that consider dividend decisions to be
irrelevant and
b. Theories that consider dividend decisions to be
an active variable influencing the value of the
firm.

7. In the latter, there are 2 extreme views that is:
i. Dividends are good as they increase the shareholder
value
ii. Dividends are bad since they reduce shareholder
value.
The following are some of the models that have critical
evaluation on these points
1. Walter’s model on the Relevance of Dividends
2. Gordon’s model on the Relevance of Dividends and
3. The Miller-Modigliani(MM) Hypothesis about Dividend
Irrelevance.
These models shall be explained in the subsequent

8. DETERMINANTS OF DIVIDEND
POLICY.
1. STABILITY OF EARNINGS.
2. LIQUIDITY OF FUNDS.
3. PAST DIVIDEND RATES.
4. RATE OF ASSET EXPANSION.
5. PROFIT RATE.
6. ABILITY TO BORROW.
7. CONTROL.
8. NEED TO REPAY DEBT.
9. MAINTENANCE OF A TARGET DIVIDEND.
10.NATURE OF OWNERSHIP.

9. DETERMINANTS OF DIVIDEND
POLICY…
 11. TIMING OF INVESTMENT OPPORTUNITIES.
 12. EFFECT OF TRADE CYCLES.
 13. LEGEAL REQUIREMENTS.
 14. GOVERNMENT POLICY.
 15. CORPORATION TAXATION POLICY.

10. TYPES OF DIVIDEND
 Regular dividend
 Interim dividend
 Stock dividend
 Script dividend
 Bond dividend
 Property dividend
 Proposed dividend
 Unclaimed dividend
 Liquid dividend
 Cash dividend

11. WALTER’S MODEL
Introduction:
Professor James E Walter argues that the choice
of dividend policy almost always affect the value
of the firm. His model, one of the earlier
theoretical works, shows the importance of
relationship between the firm’s rate of return(r)
and its cost of capital(k) in determining the
dividend policy that will maximize the
shareholders wealth.

12. ASSUMPTION
Walters model based on the following
assumption:-
 Internal financing
 Constant return and cost of capital
 100% payout or retention
 Constant EPS and DIV
 Infinite time

13. P = DIV + (EPS-DIV)r/k
k k
Here P = Market price per share
DIV= Dividend per share
EPS= Earning per share
r = Firm’s average rate of return
k = Firms cost of capital
Walter’s Formula to determine the market price per shar
is as follows:

14. CASES OF WALTER’S
MODEL.
 Growth firm: Internal rate more than the
opportunity cost of capital
For example:
r = 20% P=DIV + (EPS – DIV)r/k
K = 15% k k
EPS = Rs 4 = 4+(0)0.20/015
DIV = Rs 4 0.15
= Rs 26.67

15.  Normal firm : Internal rate equals opportunity
cost of capital
For example
r = 15% P=DIV+ (EPS-DIV)r/k
k = 15% k k
EPS=Rs 4 =4+(0)0.15/0.15
DIV=Rs 4 0.15
= Rs26.67

16.  Declining firm : internal rate less than
opportunity cost of capital
For example
r = 10% P=DIV+(EPS-DIV)r/k
k = 15% k k
EPS=Rs 4 =4+(0)0.15/0.15
DIV =Rs 4 0.15
=Rs26.67

17. Here you can see that all price is similar for all
the three firms, now if we compute the new price
for all the firms. Take dividend is Rs 2 instead of
Rs4 other things remain same
The res result also change
in growth firm Rs 31.11
normal firm Rs 26.67
declining firm Rs 22.22

18. CRITISISMS OF WALTER’S
MODEL
 No external financing
 Constant return
 Constant opportunity cost of capital

19. GORDON’S MODEL
 Gordon's theory contends that dividends are
relevant. This model is of the view that
dividend policy of a firm affects its value.
 He relates the market value of the firm to the
dividends of the firm.

20. ASSUMPTIONS OF
GORDON’S MODEL
 All re equity firms
 There is no external financing
 There is constant return
 The cost of capital is constant
 There is perpetual earnings
 No taxes
 Constant retention
 Cost of capital will be greater than growth rate.

21. FORMULA BY GORDAN
Po=EPS(1-b)
k-br
Where EPS is earnings per share
b is retention ratio(100-payout%)
k is cost of capital
br is rate of return*retention rate

22. A ILLUSTRATION ON
GORDON’S MODEL
 Taking a growth firm where r>k
r=0.15 k=0.10 EPS(1)=Rs10
When pay out ratio is 40%
g=br=o.6*0.15=0.09
p=10(1-0.6)
0.10-0.09
= 4 =Rs400
0.01

23.  When payout ratio is 60%
g=br=0.4*0.15=0.06
p=10(1-0.4)
0.10-0.06
= 6 =Rs150
0.04

24.  When payout ratio is 90%
g=br=0.10*0.15=0.015
p=10(1-0.1)
0.10-0.015
= 9 =Rs106
0.085

25. IN A DECLINING FIRM r<k
 When payout ratio is 40% r=0.08
g=br=o.6*0.08=0.048 k=0.10
p=10(1-0.6) eps(1)=Rs10
0.10-0.048
= 4 =Rs77
0.052

26.  When payout ratio is 60%
g=br=0.4*0.08=0.032
p=10(1-0.4)
0.10-0.032
= 6 =Rs88
0.068

27.  When payout ratio is 90%
g=br=0.10*0.08=0.008
p=10(1-0.1)
0.10-0.008
= 9 =Rs98
0.092

28. IN A NORMAL FIRM WHERE
r=k
 Payout ratio is 40% r=0.10
g=br=0.60*0.10=0.06 k=0.10
p=10(1-0.6) eps(1)=Rs10
0.10-0.06
= 4 =Rs100
0.04

29.  Payout ratio is 60%
g=br=0.40*0.10=0.04
p=10(1-0.4)
0.10-0.04
= 6 =Rs100
0.06

30.  Payout ratio is 90%
g=br=0.10*0.10=0.01
p=10(1-0.1)
0.10-0.01
= 9 =Rs100
0.09

31. MILLER-MODIGLIANI MODEL
According to him, under a perfect market situation
the dividend policy of a firm is irrelevant, as it
does not affect the value of the firm.
A firm operate in perfect capital market condition
may face one of the following three situation
regarding the payment of dividends:
1.The firm has sufficient cash to pay dividends
2. 1.The firm does not have sufficient cash to pay
dividends & therefore issue new share to finance
dividends
3.The firm does not pay dividend, but shareholder
need cash

32. In first situation, shareholder get cash but the
firm’s assets reduce(its cash balance)
In second situation, two transaction take place:
first existing shareholder get dividends but
they lose value of their claim on assets
reduces. Second new shareholders part their
cash in exchange for new shares at “FAIR
PRICE PRE SHARE.”
In third situation, shareholder can create a
“HOME MADE DIVIDEND” by selling their
share at market price

33. PROBLEM AND SOLUTION
Himgiri company issues 2crore shares at 100
per share.
Firm made new investment & yield 20crore
positive return.
Firm wants to pay dividend of Rs15.
Firm issues new share it pay dividends.
How the firm value be affected if it does not pay
dividend & if it pays dividend

34. If firm does not pay dividend:
Firm’s current value is 2*100=200crore
After the capex the value will increase to
200+20=220crore.
If the firm does not pay dividend the value per
share will be 220/2=110Rs

35.  If the firm pays dividends of Rs15:
 Firm need 30crore(15*2)
 To raise 30crore it has to issue new shares.
 Value of firm after paying dividend will be- 110-15=95
 Shareholder get dividend but incur loss of 15Rs in the
firm of reduced share value.
 Firm issues(30crore/95) 31.6lakh share to raise
30crore.
 Firm has 2.316crore share at 95 per share.
 Thus value of firm is 2.316*95=220crore
 That means no net gain/loss for shareholder & firm
value remain unaltered

36. ASSUMPTIONS
 Perfect capital market
 No taxes
 Investment policy
 No risk

37. CALCULATION OF MM MODEL
THROUGH FORMULA
 P0 = 1/(1 + ke) x (D1 + P1)
 Where:
 P0 =Prevailing market price of a share
 ke = cost of equity capital
 D1 = Dividend to be received at the end of
period 1 and
 P1 = Market price of a share at the end of
period 1.

38. Market price of share at end of
the period
 P1=P0(1+Ke)-D1
 Where:
 P1=Market price of
share at end of the
period
 P0=Market price of
share at beginning of
the period
 Ke= cost of equity
 D1= dividend at the end
of the period
Value of the firm
 Value of the firm, nP0 =
(n + ∆ n) P1 – I + E /(1 +
ke)
Where:
 n = number of shares
outstanding at the
beginning of the period
 ∆ n = change in the
number of shares
outstanding during the
period/ additional shares
issued.
 I = Total amount required
for investment
 E = Earnings of the firm

39.  A company whose capitalization rate is
10% has outstanding shares of 25,000
selling at Rs100 each. The firm is
expecting to pay a dividend of Rs5 per
share at the end of the current financial
year. The company's expected net
earnings are Rs250,000 and the new
proposed investment requires Rs500,000.
Prove that using MM model, the payment
of dividend does not affect the value of the
firm.

40. LIMITATION OF MM MODEL
 Assumption of perfect capital market is
unrealistic
 Investors cannot be indifferent between
dividend & retained earnings

41. THANK YOU
Presented by: mahadeva prasad.M
1st M.F.M
Manasa gangotri
mysore