2. Career Point Cares
INTRODUCTION
Dividend- Profit
distributed to
shareholders
Maintaining cash
flow
Dividend payout
ratio= DPS/ EPS
*100
Dividend
Dates
Declaration
Date
Record
Date
Ex-Date
Payment
Date
Determinants
of Dividend
D/P ratio
Stability
Constraints &
restrictions
Owner
considerations
Capital market
Inflation
3. Career Point Cares
CONCEPTS
Near Vs Distant Dividend
Preference for Current Income
Transaction and Inconvenience Costs
Information content of Dividend
Institutional Restrictions
Flotation Cost
Tax Effect
Market Imperfection
5. Career Point Cares
RELEVANCE THEORY
• Gordon’s Dividend Capitalization Model
• Assumptions- equity firm, constant r, Ke ,retention ratio &
br (growth)
• Arguments- Investors avoid risk, prefer current dividend ,
can pay higher price for current dividend
• “Bird-in-hand” argument
P=
E(1 - b)
Ke – br
6. Career Point Cares
Walter's Dividend Model
• Assumptions- Retained earnings only source, constant r, Ke, no change in the key
variables, indefintie life
• Value of share as sum of present value of all dividends and capital gains of future
• P = D+ [r / Ke] [E - D]
Ke
Conclusions
• r > ke, D/P ratio inversly related to market value, optimum D/P ratio= 0
• r < ke, D/P ratio directly related market value, optimum D/P ratio=100%.
• r = ke, market value constant irrespective of D/P ratio, no optimum D/P ratio
Limitation
• Applicable only to all-equity firms
• Assumption of constant r and Ke is not realistic
8. Career Point Cares
IRRELEVANCE THEORY
• Miller and Modigliani Model (MM Model)
Assumptions
• Perfect markets, no transactions costs, no floatation costs, no taxes.
• Constant investment policy and r
Arguments
• Arbitrage, No net gain
• cost of capital would be independent of D/P ratio
• P0 = 1/(1 + ke) x (D1 + P1), nP0= (n + ∆ n) P1 - I + E
(1 + ke)
Limitations
• Perfect market, taxes, floatation& transaction costs
• Investors will not be different b/w dividend and retained earnings
9. Career Point Cares
Ques. Ke =10% ; 25,000 shares selling at $100 each, D= $5/ share, earnings
$250,000, new investment requires $500,000.
• Value of the firm when dividends are paid:
– Price per share at the end of year 1:
P0 = 1/(1 + ke) x (D1 + P1) => $100 = 1/(1 + 0.10) x ($5 + P1)
P1 = $105
– Amount required to be raised from the issue of new shares:
∆ n P1 = I - (E - nD1)
=> $500,000 - ($250,000 - $125,000) => $375,000
– Number of additional shares to be issued:
∆n = $375,000 / 105 => 3571 shares
– Value of the firm:
=> (25,000 + 3571) (105) - $500,000 + $250,000 = $2,500,000
(1 + 0.10)
10. Career Point Cares
• Value of the firm when dividends are not paid:
– Price per share at the end of year 1:
P0 = 1/(1 + ke) x (D1 + P1) => $100 = 1/(1 + 0.10) x ($0 + P1)
P1 = $110
– Amount required to be raised from the issue of new shares:
=> $500,000 - ($250,000 -0) = $250,000
– Number of additional shares to be issued:
=> $250,000/$110 = 2273 shares
– Value of the firm:
=> (25,000 + 2273) (110) - $500,000 + $250,000 = $2,500,000
(1 + 0.10)
13. Career Point Cares
CONCLUSION
Various theories & ideas about dividend, its distribution &
its effect on valuation of the firm
Unrealistic assumptions and situation
Dividend distribution do affect valuation of the firm