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other !#r!oses$ or To distri%#te earnings in the or" o dividend a"ong shareholders$ or To retain so"e earning and to distri%#te re"aining earnings to shareholders&
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whether-
Availa%ility o Divisi%le Pro its Availa%ility o Pro ita%le (einvest"ent )!!ort#nities Availa%ility o *i+#idity ,n lation - ect on .ar/et Prices Co"!osition o Shareholding Co"!any0s own !olicy regarding sta%ility o dividend Contract#al restrictions %y 'inancial ,nstit#tions -1tent o access to e1ternal so#rces Attit#de and )%2ectives o .anage"ent
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Dividend Theories
Relevance Theories
3i&e& which consider dividend decision to %e relevant as it a ects the val#e o the ir"4
Irrelevance Theories
3i&e& which consider dividend decision to %e irrelevant as it does not a ects the val#e o the ir"4
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5ordon0s .odel
Walter0s .odel
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to Pro & 5ordon, Dividend Policy al"ost always a ects the val#e o the ir"& He Showed how dividend !olicy can %e #sed to "a1i"i8e the wealth o the shareholders& The "ain !ro!osition o the "odel is that the val#e o a share re lects the val#e o the #t#re dividends accr#ing to that share& Hence, the dividend !ay"ent and its growth are relevant in val#ation o shares& The "odel holds that the share0s "ar/et !rice is e+#al to the s#" o share0s disco#nted #t#re dividend !ay"ent&
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The ir" is an all e+#ity ir" and has no de%t -1ternal inancing is not #sed in the ir"& (etained earnings
re!resent the only so#rce o inancing& The internal rate o ret#rn is the ir"0s cost o ca!ital 0/0& ,t re"ains constant and is ta/en as the a!!ro!riate disco#nt rate& '#t#re ann#al growth rate dividend is e1!ected to %e constant& 5rowth rate o the ir" is the !rod#ct o retention ratio and its rate o ret#rn& Cost o Ca!ital is always greater than the growth rate& The co"!any has !er!et#al li e and the strea" o earnings are !er!et#al& Cor!orate ta1es does not e1ist& The retention ratio 9%0 once decided #!on, re"ain constant& There ore, the growth rate g:%r, is also constant orever&
r#n the share !rices re lect only the !resent val#e o e1!ected dividends& (etentions in l#ence stoc/ !rice only thro#gh their e ect on #t#re dividends& Walter has or"#lated this and #sed the dividend to o!ti"i8e the wealth o the e+#ity shareholders&
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D < r 3--D4 /
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?& ,n case o Declining .ar/et 6al#e o Share .ar/et 6al#e o share ir" i&e& where r @ / increases decreases No change in val#e o Share
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the co"!anyE What sho#ld %e the !rice o share at o!ti"#" !ayo#t ratioE How shall this !rice %e a ected i di erent !ayo#t 3say FBC4 were e"!loyedE
=B& The -+#ity Ca!itali8ation rate is =BC& ,nternal (ate o ret#rn on retained earnings is ?BC& Using Walter0s or"#laD
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the co"!anyE What sho#ld %e the !rice o share at o!ti"#" !ayo#t ratioE How shall this !rice %e a ected i di erent !ayo#t 3say FBC4 were e"!loyedE
=B& The -+#ity Ca!itali8ation rate is =BC& ,nternal (ate o ret#rn on retained earnings is =BC& Using Walter0s or"#laD
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The -+#ity Ca!itali8ation rate is ?BC& ,nternal (ate o ret#rn on retained earnings is =BC& Using Walter0s or"#laD
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the
co"!anyE What sho#ld %e the !rice o share at o!ti"#" !ayo#t ratioE How shall this !rice %e a ected i di erent !ayo#t 3say FBC4 were e"!loyedE
Illustration 4
The earning !er share o a co"!any are (s&
=B and the rate o ca!itali8ation a!!lica%le to it is =BC& The co"!any has %e ore it the o!tion o ado!ting a !ayo#t o ?BC or GBC or FBC& Using Walter0s or"#la, co"!#te the "ar/et val#e o the co"!any0s share i the !rod#ctivity o retained earning is 3a4 ?BC 3%4 =BC and 3c4 FC& What in erence can %e drawn ro" the a%ove e1erciseE
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sit#ation, the dividend !olicy o a ir" is irrelevant as it does not a ect the val#e o the ir"& They arg#e that the val#e o the ir" de!ends on the ir"0s earnings and ir"0s earnings are in l#enced %y its invest"ent !olicy and not %y the dividend !olicy
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A
Depends on
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Depends on
Assu
Per ect Ca!ital .ar/etD This "eans thatD The investors are ree to %#y and sell sec#rities& The investors %ehave rationally& There are no transaction costH lotation cost& They are well in or"ed a%o#t the ris/-ret#rn on all ty!es o sec#rities& No investor is large eno#gh to a ect the "ar/et !rice o a share& No Ta1es 'i1ed ,nvest"ent Policy No (is/
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P= : .ar/et Price o a share at the end o the !eriod one D= : Dividend to %e received at the end o !eriod one Ke : Cost o e+#ity ca!ital
a ter dividend declared, is calc#lated %y a!!lying the ollowing or"#laD P= < D= = < Ke P =
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Where, JN , n D= P=
: : : : : :
Change in the n#"%er o shares o#tstanding d#ring the !eriod& Total ,nvest"ent a"o#nt re+#ired or ca!ital %#dget -arning o net inco"e o the ir" d#ring the !eriod N#"%er o shares o#tstanding at the %eginning o the !eriod Dividend to %e received at the end o !eriod one .ar/et !rice o a share at the end o !eriod one
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the
Ta1es -1ist No i1ed invest"ent Policy ,nvestor0s desire to o%tain c#rrent inco"e
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