Download presentation
Presentation is loading. Please wait.
Published byTyrone Nichols Modified over 8 years ago
1
DIVIDEND THEORY CHAPTER 17
2
LEARNING OBJECTIVES Highlight the issues of dividend policy Critically evaluate why some experts feel that dividend policy matters Discuss the bird-in-the-hand argument for paying current dividends Explain the logic of the dividend irrelevance Identify the market imperfections that make dividend policy relevant Understand information content of dividend policy 2
3
INTRODUCTION Dividend policy involves the balancing of the shareholders’ desire for current dividends and the firm’s needs for funds for growth. 3
4
Issues in Dividend Policy Earnings to be Distributed – High Vs. Low Payout. Objective – Maximize Shareholders Return. Effects – Taxes, Investment and Financing Decision. 4
5
Relevance Vs. Irrelevance Walter's Model Gordon's Model Modigliani and Miller Hypothesis The Bird in the Hand Argument Informational Content Market Imperfections 5
6
DIVIDEND RELEVANCE: WALTER’S MODEL Walter’s model is based on the following assumptions: Internal financing Constant return and cost of capital 100 per cent payout or retention Constant EPS and DIV Infinite time 6
7
Walter’s formula to determine the market price per share: 7
8
Optimum Payout Ratio Growth Firms – Retain all earnings Normal Firms – Distribute all earnings Declining Firms – No effect 8
9
9 Example: Dividend Policy: Application of Walter’s Model
10
Criticism of Walter’s Model No external financing Constant return, r Constant opportunity cost of capital, k 10
11
DIVIDEND RELEVANCE: GORDON’S MODEL Gordon’s model is based on the following assumptions: All-equity firm No external financing Constant return Constant cost of capital Perpetual earnings No taxes Constant retention Cost of capital greater than growth rate 11
12
Valuation Market value of a share is equal to the present value of an infinite stream of dividends to be received by shareholders.
13
Example: Application of Gordon’s Dividend Model 13
14
It is revealed that under Gordon’s model: 14
15
DIVIDEND AND UNCERTAINTY: THE BIRD-IN-THE-HAND ARGUMENT Argument put forward, first of all, by Kirshman Investors are risk averters. They consider distant dividends as less certain than near dividends. Rate at which an investor discounts his dividend stream from a given firm increases with the futurity of dividend stream and hence lowering share prices.
16
DIVIDEND IRRELEVANCE: THE MILLER–MODIGLIANI (MM) HYPOTHESIS According to M-M, under a perfect market situation, the dividend policy of a firm is irrelevant as it does not affect the value of the firm. They argue that the value of the firm depends on firm earnings which results from its investment policy. Thus when investment decision of the firm is given, dividend decision is of no significance. It is based on the following assumptions:- Perfect capital markets No taxes Investment policy No risk
17
Market Imperfections 1. Tax Differential – Low Payout Clientele 2. Flotation Cost 3. Transaction and Agency Cost 4. Information Asymmetry 5. Diversification 6. Uncertainty – High Payout Clientele 7. Desire for Steady Income 8. No or Low Tax on Dividends 17
18
Informational Content of Dividend …. In an uncertain world in which verbal statements can be ignored or misinterpreted, dividend action does provide a clear cut means of ‘making a statement’ that speaks louder than a thousand words. — Solomon
Similar presentations
© 2024 SlidePlayer.com Inc.
All rights reserved.