This document discusses dividend decision and theories. It defines dividends as the portion of profits distributed to shareholders. There are different types of dividends such as interim, final, stock, and scrip dividends. Dividend decision is influenced by legal provisions and is treated as a financing decision aimed at wealth maximization. The document discusses various dividend theories including the residual dividend policy, Modigliani-Miller's irrelevance theory, Walter's model, Gordon's model, and their underlying assumptions. It also covers factors influencing dividend policy and different approaches a company can take to its dividend policy.

1. 1
Dividend Decision
and Theories
Apurba
Akshata
Bhupesh
Gagan
Nikhil
Pradeep
Shashank

2. CONCEPT OF DIVIDEND
• The term dividend in normal usage refers to that portion of
profits after tax, which is distributed among the shareholders
of the firm.
• Dividends are periodic cash payments by the company.
• A company may have a preference as well as equity share
capital and dividends may be paid on both the type of capitals.

3. • Dividend paid represents a cash flow and the dividend
decision is regarded as a financing decision.
• Dividend decision is treated as a wealth maximization
decision.
• Payments of dividends to shareholders has a strong influence
on the market price of the shares.

4. TYPES OF DIVIDEND
The types of dividend are as follows:
• Interim Dividend
• Final Dividend
• Stock Dividend
• Scrip Dividend

5. LEGAL DECISION ON DIVIDENDS
• The dividend decision is based on the legal provisions under the
Companies Act 1956, Companies Rules 1975 provide that before dividend
declaration a percentage of profit as specified below should be transferred
to the reserves of the company:
a) Where the dividend proposed exceeds 10% but not 12.5% of the paid up
the capital, the amount transferred to the reserves shall not be less than
2.5% of the current profits.
b) Where the dividend proposed exceeds 12.5% but not 15%, the amount
transferred to the reserves shall not be less than 5% of the current
profits.
c) Where the dividend proposed exceeds 15% but not 20%, the amount
transferred to reserves shall not be less than 7.5% of the current profits.

6. • As per Indian Companies Act, the following are narrated as
legal points on dividend:
a) Companies can pay only cash dividends and bonus shares.
b) Dividends can be paid out of the firms current profits after
providing for depreciation and transferring to reserves.
c) Where the dividend profits exceeds 20%, the amount
transferred to the reserves shall not be less than 10% of the
current profits.
d) The rate of the dividend declared shall not exceed the average
of the rates at which dividend was declared by it in 5 years
immediately preceding that year or 10% of its paid up capital,
whichever is less.

7. DIVIDEND THEORIES
• Residual Dividend policy
• Modigliani – Miller’s
Approach
Irrelevance
theory
• Walter’s Model
• Gordon’s Model
Relevance
theory

8. IRRELEVANCE CONCEPT OF DIVIDEND
• The basic theme of irrelevance approach of dividend is
that the dividend policy has no effect on the wealth of
shareholders or the price of the share
Residual Dividend policy:
• The shareholder’s principal desire is to earn higher
returns on their capital.
• Here the dividend policy is basically a financing decision.
• If there are excess earnings, then pay the remainder out
in dividends.

9. Example – Residual Dividend Policy
• Given
– Need Rs.5 cr for new investments
– Aims at having debt at 40%
– Net Income = Rs.4 cr
• Finding dividend
– 40% financed with debt (2 cr)
– 60% financed with retained earnings (3 cr)
NI – equity financing = Rs.1 cr, paid out as
dividends

10. MODIGLIANI-MILLER’S APPROACH
(MM)
• The sum of the discounted value per share after dividend
payments is equal to the market value per share before
dividend is paid.
• M-M’s irrelevance approach is based on arbitrage argument.
Arbitrage refers to entering into two such transactions as
exactly balanced or completely offset each other.
• M-M’s argument of irrelevance of dividend remains
unchanged whether external funds are obtained by means of
share capital or borrowings.

11. ASSUMPTIONS OF M-M APPROACH
• There exists a perfect capital market.
• There does not exist taxes.
• Firm’s investment policy is well planned.
• There is no uncertainty as to the future
investments and the profits.

12. • M-M approach contain mathematical formulation to
prove the irrelevance of dividend decision.
– The MV of a share in the beginning of the year is equal to
the present value of dividends paid at the year end plus the
MV at the end of the year.
P₀=D₁+P₁ P1 =Po(1+K) – D1
Where (1+K)
P₀=Existing price of a share
K=Cost of capital
D₁=Dividend to be received at the year end
P₁=Market value of a share at the end year

13. • If there is no additional financing from external sources, value of the firm
will be equal to number of shares (n) multiplied by the price of each share
(Po)
V= nP₀ =n(D₁+P₁)
(1+K)
• If the firm issues ‘m’ number of shares to raise funds at the end of the year
1, value of the firm at the time 0 will be:
V=nP₀=n(D₁ +P₁)+mP₁ -mP₁/(1+K)
=nD₁+nP₁+mP₁-mP₁/1+K
=nD₁+(n+m)P₁-mP₁/1+K
Where;
mP₁ =total amount of funds raised by the issue of new shares

14. • Thus total amount of new amount of new shares that the firm
will issue to finance its investment programs will be:
mP₁ = I – ( X - nD₁ )
mP1 = I - X + nD₁
Where
mP₁ =total amount of funds raised by the issue of new shares
I = total amount of the investment
X=total amount of net profits
nP₀= nD₁+(n+m)P₁-(I-X+nD₁)
(1+K)
Thus we get the following equation:
=(n+m)P₁- I + X
(1+K)

15. EXAMPLE
• A ltd. has currently 1,00,000 shares of Rs 100.each.The firm
wants to declare a dividend of Rs 4 per share at the end of the
current financial year. The capitalization rate for the risk class
is 10%. What will be the price of a share the end year if:
a) A dividend is declared.
b) A dividend is not declared.
c) Assuming that the firm pays a dividend, has the net profit of
Rs 6,00,000 and makes new investments of Rs 10,00,000 during
the period, how many new shares must be issued?
Use MM model..

16. Solution
• P1 = Po [ 1 + K ] – D1
[a] Value P1 = Rs.100 [ 1 + .10 ] – Rs.4 = Rs.106
[b] Value P1 when dividend is not paid :
Rs.100 [ 1 + .10 ] – 0 = Rs.110
[c] Number of new shares to be issued :
mP₁ = I – ( X - nD₁ )
m [ 106 ] = 10 lakh – [ 6 lakh – 4 lakh ]
m = 10 lakh – 2 lakh / 106
= 7548 shares

17. RELEVANCE CONCEPT OF DIVIDEND
• Resolution of uncertainty
• Dividend as information content
• Desire for current income
• Sale of additional stock at lower price
• Tax savings
• Transaction costs
• Erratic behavior of investors

18. WALTER’S APPROACH
• According to this approach dividend policy is an
active variable that influences share price and
also the value of the firm.
• He holds that the relationship between the firm s
internal rate of return and coast of capital is
crucial.
• If r > k, the firm should retain the earnings
• If k > r, the firm will distribute dividends
• If k = r, the share holders are indifferent between
retention and dividends

19. Assumptions of Walter s approach
• The firms internal rate(r) of return and its cost of
capital are constant.
• The firm distributes its entire earnings or retains
for reinvestment immediately.
• The firm has perpetual life.
• The corporate taxes do not exist.
• There is no change in the values of earnings per
share(E) and the dividend per share(D).

20. • Walter provides the following formula:
P= D +r(E-D)/K
K K
P= Market price per share
D= Dividend per share
E= Earnings per share
r = Internal rate of return
k= Cost of capital
The above equation indicates the market value of two sources of
income:
• Present value of all dividends .D/k and
• Present value of all capital gains, [ r ( E – D ) /k ] /k
= P = D+(r/k)[E-D]
K

21. EXAMPLE
• The earnings per share of a company are Rs 20. It
has an internal rate of return of 15% and the
capitalization rate of its risk class is 12 %. If Walter`s
model is used:
a) What Should be the optimum payout ratio of the
firm?
b) What would be the price of the share at this payout
and also at 60% payout?

22. SOLUTION
= P = D+(r/k)[E-D]
K
• At the optimum payout payout ratio:
P₀=[0+(0.15/0.12)[20-0]
P₀=1.25*20/0.12
P₀=Rs 208.33
• At 60%payout ratio, the price will be:
P₀=[12+(0.15/0.12)[20-12]
P₀=22/0.12
P₀=Rs 183.33

23. GORDON’S METHOD
• Gordon’s Dividend Equalization model is based on
following assumptions:
a) The firm is in all-equity firm.
b) r and k remains unchanged.
c) The firm has perpetual life.
d) There are no corporate taxes.
e) The retention ratio , b, is constant.
growth rate, g =br is constant
f) K is greater than br, which is equal to g.

24. • The original formula is :
P₀ = D
K-g
Where
g = br
b =retention ratio
r =rate of the return
and therefore D = (1-b ) E, then
P₀ = E (1-b)
k-br
where
P₀ =price of the shares
E =Earnings per share
(1-b)=% of earnings distributed as dividends
K = capitalization rate or cost of capital
br = growth rate

25. EXAMPLE
• A company has a total share capital of 50000 equity
shares of Rs 10 each. The company’s rate of return on its
total investment of Rs 5,00,000 is 12% and has a policy
of retaining 40% of the earnings. If the appropriate
capitalization rate is 10% determine the price of its
share using Gordon’s model.
What shall happen to the price,if the company has a
payout of 80% and 20%?

26. SOLUTION
P₀=E(1-b)
k-br
=r*A(1-b)
k-br
• At 60% payout ratio, the price will be:
E=0.12*10=1.20
P₀= 1.20(1-0.40) =Rs 13.85
0.10-(0.40*0.12)
• At 80% payout ratio, the price will be:
P₀=1.20(1-0.20) = Rs 12.63
0.10-(0.20*0.12)
• At 20% payout ratio, the price will be:
P₀=1.20(1-0.80) = Rs 60
0.10-(0.80*0.12)

27. DIVIDEND POLICY
• Dividend policy refers to the policy relating to the
distribution of profits as dividends.
• The important aspect of dividend policy is to decide
about the earnings to be distributed to the shareholders
and amount to be retained in the firm.
• Dividend policy adopted by the firm should be one,
which helps in maximizing its contribution towards
increasing the wealth of the shareholders.
• A firm’s dividend policy includes two dimensions:
a) Dividend pay out ratio
b) Stability of dividends

28. NATURE OF DIVIDEND POLICY
a) Tied up with retained earnings
b) Decision making and problem solving
c) Impact on shares
d) Optimal dividend policy

29. OBJECTIVES OF DIVIDEND POLICY
a) Wealth maximization
b) Sufficient financing

30. BASIC ISSUES INVOLVED IN DIVIDEND
POLICY
a) Cost of capital
b) Realization of objectives
c) Shareholder’s group
d) Realize of corporate earnings

31. FACTORS INFLUENCING DIVIDEND
POLICY
a) Legal issues
b) Size of the earnings
c) Investment opportunities and shareholder’s
preference
d) Liquidity position
e) Management’s attitude towards control
f) Capital market
g) Contractual restrictions
h) Profit rate and stability of earnings
i) Control
j) Inflation

32. TYPES OF DIVIDEND POLICY
• A company may follow a wide variety of
dividend policies. They are as follows:
a) Stable dividend policy
b) Policy of no immediate dividends
c) Policy of regular and extra dividend
d) Policy of regular bonus shares
e) Policy of regular dividends plus bonus shares
f) Policy of irregular dividends

33. Thank You