DIVIDEND POLICY

What is dividend ???

The term dividend refers to that portion of
profit which distributed among the
owners/shareholders of the company.
It is the reward of the shareholders for
investments made by them in the shares of the
company.
The investors are interested in earning the
maximum ROI and to maximize their wealth,
while a company, on the other hand, needs to
provide funds to finance its long-term
growth.
What is dividend decision ???
Should the profit be ploughed back to finance
the investment decisions?
Whether any dividend be paid? If yes, how
much dividend be paid?
When these dividend be paid? Interim or
Final?
In what form the dividends be paid? Cash
dividend or stock dividend?
Dividend Policy
Dividend policy of a firm affects both the long-
term financing and the wealth of shareholders.
It deals with the firms decision to pay
dividends must be reached in such a manner
so as to equitably apportion the distributed
profits and retained earnings.
The company should, therefore, distribute a
reasonable amount as dividends to its
members and retain the rest for its growth and
survival.
Dividend policy and value of the
firm
Dividend policy is basically concerned with
deciding whether to pay dividend in cash now,
or to pay increased dividends at a later stage
or distribution of profits in the form of bonus
share.
What is sound rational for dividend
payments? in the light of the objective of
maximization of the value of the share
Dividend policy and value of the
firm
Different models have been proposed to
evaluate the dividend policy decision in
relation to value of the firm.
Two schools of thought have emerged on the
relationship between the dividend policy and
the value of the firm.
Relevance of dividend policy.
Irrelevance of dividend policy.
Relevance of dividend policy
The firm pay dividend and view such dividend
payments positively.
The investors also expect and like to receive
dividend income on their investments.
The firms not paying dividends may be
adversely rated by the investors.
It may be argued that the dividend policy has
an effect on the market value of share and the
value of firm.
Walters Model
Assumption:
1. All the investment proposals of the firm are to
be financed through the retained earning only
and no external finance is available to the
firm.
2. The business risk of the firm remains same
even after fresh investment decision are
taken. In other words ROI r and cost of
capital k are constant.
3. The firm has an indefinite life.
Walters Model
This model considers that the investment
decision and dividend decisions are inter-
linked.
A firm should or should not pay dividends
depends upon whether it has got the suitable
investment opportunities to invest the retained
earnings or not.
Walters Model
According to this model, a firm can maximize
the market value of its share and value of the
firm by adopting a dividend policy as follows:
1. If r>k - retention of 100% profit
2. If r < k pay 100% profit as dividend
3. If r = k the dividend is irrelevant

D + (E D) (r/k)
k k
P =
Gordons Model
This model is also based on the assumption
similar to that made in Walters model.
However, two additional assumptions made by
this model are as follows:
The growth rate of the firm the firm g = br
The cost of capital is constant and is more than
growth rate k > g
Gordons Model
Under this model, the market price of share is
can be calculated as follows:

E(1-b)
k g
The profit which is not distributed to the owners
and kept in the business is known as retained
earning

P =