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Module 6 FM - VG

The document discusses dividend policy, which involves the distribution of a company's profits to shareholders and the factors influencing this decision, such as ownership structure and profitability. It outlines two key models: Walter's Model, which emphasizes the relationship between internal rate of return and cost of capital, and Gordon's Model, which relates market value to dividend policy under certain assumptions. Both models highlight the importance of dividend decisions on shareholder wealth and company financing.

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3 views11 pages

Module 6 FM - VG

The document discusses dividend policy, which involves the distribution of a company's profits to shareholders and the factors influencing this decision, such as ownership structure and profitability. It outlines two key models: Walter's Model, which emphasizes the relationship between internal rate of return and cost of capital, and Gordon's Model, which relates market value to dividend policy under certain assumptions. Both models highlight the importance of dividend decisions on shareholder wealth and company financing.

Uploaded by

ypratik817.alt
Copyright
© All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd

FM Module 6: Dividend

Policy

By Vikas Gupta
INTRODUCTION:

A dividend is a share of profits and retained earnings that a company pays


out to its shareholders. When a company generates a profit and accumulates
retained earnings, those earnings can be either reinvested in the business or
paid out to shareholders as a dividend. The annual dividend per share
divided by the share price is the dividend yield.
Objectives of Dividend Policy
Effect of dividing it’s net earnings into two parts: Retained earning & dividend.
Dividend Policy effects both long term financing & wealth of shareholders.
Firm’s decision to pay dividend may be influenced by two possible view points:
1. Firm’s need for funds
2. Shareholder’s need for income
Other Factors affecting an entities dividend
1. Ownership structure
decision
2. Age of corporation
3. Different shareholder’s expectations
4. Leverage
5. Future financial requirements/reinvestment opportunity
6. Business cycles
7. Changes in government policies
8. Profitability
9. Taxation policy
10. Trends of profits
11. Liquidity
12. Inflation
13. Legal rules
14. Control objectives
15. Repayment of debt
7
DIVIDEND THEORIES
Walter’s Model
Professor James E. Walter argues that the choice of dividend policies almost always affects the value of the enterprise. His
model shows clearly the importance of the relationship between the firm’s internal rate of return (r) and its cost of capital (k)
in determining the dividend policy that will maximize the wealth of shareholders.

Walter’s model is based on the following assumptions:


1. The firm finances all investment through retained earnings; that is debt or new equity is not issued;
2. The firm’s internal rate of return (r), and its cost of capital (k) are constant
3. All earnings are either distributed as dividend or reinvested internally immediately.
4. Beginning earnings and dividends never change. The values of the earnings per share (E), and the divided per share (D)
may be changed in the model to determine results, but any given values of E and D are assumed to remain constant forever in
determining a given value.
5. The firm has a very long or infinite life.
Walter’s Model

9
Gordon’s Model
One very popular model explicitly relating the market value of the firm to dividend policy is developed by Myron Gordon.
Assumptions:
Gordon’s model is based on the following assumptions.
1. The firm is an all Equity firm
2. No external financing is available
3. The internal rate of return (r) of the firm is constant.
4. The appropriate discount rate (K) of the firm remains constant.
5. The firm and its stream of earnings are perpetual
6. The corporate taxes do not exist.
7. The retention ratio (b), once decided upon, is constant. Thus, the growth rate (g) = br is constant forever.
8. K > br = g if this condition is not fulfilled, we cannot get a meaningful value for the share.
According to Gordon’s dividend capitalisation model, the market value of a share (Pq) is equal to the present value of an
infinite stream of dividends to be received by the share.
Gordon’s Model

11

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