DIVIDEND POLICY

Dividends
Dividends are payments made to stockholders from a firm's earnings, whether those earnings were generated in the current period or in previous periods.

Types of Dividend
Final Dividend Interim Dividend Preference Dividend

Types of Dividend Policies

Constant Dividend Payout Policy:
Payment of Fixed percentage of net earning every year

Constant Dividend Rule Policy:

Payment of dividend at a constant rate Dividend equalization reserve

Minimum Dividend Rule Policy

Appropriate payout ratio based on net preferences for dividend over capital gain taxes

Dividend Policy

Pay dividend
Taxable in the hands of the shareholders directly in form of Dividend Tax Dividend Payout Ratio EPS / Dividend per share

Retain the earnings

Taxable in the hands of the shareholders indirectly in form of Capital gain Tax

Retention Ratio = 100% (b) Dividend payout ratio

 Growth of a firm = ROE * Retention Ratio

g = ROE *b
There are two companies having a Low Payout ratio and a High Payout ratio, both have a return on equity of 20%.Both the companies equity shares consist of one share each of rs.100. Calculate the growth rate of the both the companies and comment upon it

Walters Model
Dividend policies affect the value of the firm. Relation between the firms rate of return (r ) and its cost of capital (k) in determining the dividend policy that will maximize the shareholders value Assumptions
Internal financing all investments through retained earnings no debt or new equity Constant return and Cost of capital Firms rate of return and cost of capital are constant 100% payout or retention all earnings are either paid out as dividend or reinvested internally immediately

Walters Model
Constant EPS and Dividend Infinite time

Formula
P = Div + r/k (EPS-DIV) ___________________ k
Where
P = market price per share DIV = dividend per share EPS is earning per share R = firms rate of return K = firms cost of capital

Problem
Find value per share for the following: 1. r= 0.15 k= 0.10 EPS = Rs.10 2. r=0.10 k= 0.10 EPS = Rs.10 3. r=0.08 k = 0.10 EPS = Rs.10 Payout ratio = 0%,40%,80%,100%

 The earnings per share of B ltd is Rs. 4 and the rate of capitalization applicable is 10%. The company has before it an option of adopting (1) 50% (2) 75% and (3) 100% dividend payout ratio, compute the market price of companys shares as per Walter model if it can earn a return of 10% on its retained earnings.
(Rs.40)

 ABC Company Ltd. Is expecting 10% return on total assets of Rs.50 Lakhs. The company has outstanding shares 20,000. The directors of the company have decided to pay 40% of earning as dividend. The rate of return required by shareholders is 12.5%. The rate of return expected on investment is 15%. You are required to determine the price of the shares using Walter Model.

Earnings = 10%* 50,00,000 Earnings per shares = 5,00,000/20000 Dividend = 40% * 5,00,000 Dividend per share = 2,00,000/20000 Market price of shares = D + r/k (E-D)
____________ k

Gordon Growth Valuation Model

Known as Dividend Growth Model. Market value of the shares is equal to the present value of an infinite stream of dividends to be received by the shareholders

Formula Po = Do (1+g) _______ Ke g

Where
Po = current market price of the share Do = Current Years dividend D1 = Expected dividend Ke = expected rate of return G = Expected future growth rate of dividend

D1
_____ Ke g

 Substituting Div = EPS (1- b) G = br

Po = E(1-b) ______ Ke br
Where B = retention ratio Br= growth rate (1-b) = dividend payout ratio E = earning per share

 Calculate the market price of the share according to Gordons model where:
r= 0.15 k= 0.10 EPS = Rs.10 r = 0.10 k=0.10 EPS = Rs. 10 r = 0.08 k= 0.10 EPS = Rs.10 Calculate for each of the case retention ratios are 60 %, 40% Payout ratio = 90%

 The following data related to a firm EPS = Rs. 10, capitalization rate 10%, Retention ratio = 40% Determine the price per share under Walters Model and Gordons model if the internal rate of return is 15%, 10%, and 5%

 A company earns Rs.10 per share at an internal rate of 15%. the firm has a policy of paying 40% of earning as dividend. If the required rate of return is 10%, determine the price of the share under (i) Walters Model (ii) Gorden Model

 Welspun Ltd. Has a total investment of Rs.500,000 in assets and 50000 outstanding ordinary shares at Rs. 10 per share (par value). It earns a rate of 15% on its investments and has a policy of retaining 50% of the earnings. If the approximate discount rate of the firm s 10% determine the price of its share using Gordons Model . What will happen of the price of the share if the company has a payout of 80% or 20%

Modigliani and Miller Approach

Price of the shares of the company is determined by the earning potentiality and investment policy and not by the pattern of distribution Market value of a share in the beginning of the period is equal to the present value of dividend paid at the end of the period plus the market price of the share at the end of the period .

Formula

P = D1+P1 _____ (1+Ke)

P1 = Po (1+ Ke) D1
Where
Po = current Market Price of a Share Ke + Cost of Equity Share Capital D1 = Dividend to be received at the end of period P1= Market Price of a Share at the end of period

 The share capital of Sam industries is Rs. 10,00,000 divided into 1,00,000 equity shares of Rs.10 each. The Company is contemplating a dividend of Rs.10 per share at the end of the current year. The company belongs to a risk class for which appropriate capitalization rate is 20%. The current market price of the share is rs.100. What will be the price of the share at the end of the year if (1) Dividend is not declared (2) Dividend is declared

 Geeta trading has 1,20,000 shares outstanding and selling at rs.20 each in the market. The Company hopes to make a net income of rs.3,50,000 during the year ended on 31st march 2011. The Company is considering to pay a dividend of Rs.2 per share at the end of the current year. The capitalization rate of risk class of this company has been estimated to be 155 using MM. Dividend valuation model. What will be the price of a share at the end of the year (1) if dividend is paid and (2) if dividend is not paid. How many new shares must the company issue if the dividend is paid and the company needs Rs.7,40,000 for an approved investment expenditure during the year.

 The current market price of the shares of X Ltd. Is Rs.120 per share. The company is considering rs.6.40 per shares as dividend. The company belongs to a risk class where the cost of capital is 9.6%. Using M&M approach you are required to calculate the market price of the shares when: Dividend is declared Dividend is not declared Interpret your learning from the calculation above.

 Find the dividend pay-out ratio if EPS is Rs 10 and the amount of dividend is Rs 4.
Solution
DPR = 4/10 = 0.40 = 40%