Dividend Payouts Final

8/8/2019 Dividend Payouts Final

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Dividend Payouts

Shalini Rao (28)

M. Subha Pallavi (35)

Loknath Reddy (10)

DVD Ravi Kumar (09)

Eluri Arunkiran (16)


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Dividends

Dividends are payments made to

stockholders from a firm's earnings,whether those earnings were generatedin the current period or in previous

periods.


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Dividend Decision

One of the three basic decisions of a financial manager,the other two being investment decision and financingdecision.

Decision as to whether the firms profits should be paidas dividends retained and in what amount.

Objective: 1. maximize wealth of shareholders,

2. increase the goodwill of the firm

3.satisfy the obligations of the shareholders


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Types ofTheories


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DividendRelevance

Dividend policy is very effective for any business firm as it effects theoverall value of the firm.

Dividend policy is relevant and dividend decision form a very integralpart of the investment and financing decision of the firm.

Share holders prefer current dividends & hence there is a directrelationship between the dividend policy and the market value ofthe firm.


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Theories following this notion

1. Walters model

2. Gordons model


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W

alters Approach

Dividend policy affects the value of the firm.

Together, the cost of capital (k) and rate of return (r)determine the dividend policy that will maximize theshareholders wealth.


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Assumptions

Market value of shares is affected by the presentvalue of future anticipated dividends.

Retained earnings affect future

The firm has very and infinite life

All earnings are either distributed as dividends or

invested internally immediately.

The firm either goes for a 100% pay-out or 100%retention.


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Walter Model-Decisions


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Walter Model-criticism

It ignores the benefit of optimal capital structure.

Assumption that k remains constant does nothold good in practice.

It ignores the market price is affected by many

factors.


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G

ordons Approach

Dividend policy is relevant to the value of the

company.

Also known as the bird on hand argument.

Dividend policy is relevant as the investors prefercurrent dividends as against the future uncertaincapital gains.


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Assumptions

1. The firm is an all equity firm.

2. The corporate tax do not exist.

3. The firm has a perpetual life.4. The internal rate of return and cost of capital is

constant

5. The growth rate, (g=br) is also constant.

6. No external financing is available.


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Gordon Model-Decision

If r>k>g: company should distribute less dividend andretain high profit.

If r


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Dividend Capitalization ModelMarket value of a share is equal to the present value of future stream

of dividends.

P = E (1 b)

ke br

P=price of a share

E=earnings per shareb=retention ratio

1-b=D/P ratio, i.e. percentage of earnings distributed as dividends

ke= Capitalization rate/cost of capital

br=g=growth rate=rate of return on investment of an all equity firm.


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Irrelevanceof

Dividends

The value of a firm is unaffected by the distribution ofdividends and is determined solely by the earning powerand risk of its assets.

Value of the firm is affected by the earning capacity of thefirm i.e., the investment policy and not the dividendpolicy.


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Modigliani and Miller (MM) Hypothesis

Modigliani and Miller put forward the hypothesis thatdividend is a passive variable and it does not influence the

share valuation. Thus M-M model is known as DividendIrrelevance Model.

Modigliani and Miller provide the most comprehensiveargument that the investment decision of the firm, the

dividend payout ratio is a mere detail and that it does notaffect the wealth of owners. They argue that the value ofthe firm is determined solely by the earning power of thefirm and not its pattern of distribution of earnings that willinfluence the value of shares.


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(MM) Assumptions(1) Perfect capital markets exist and investors are rational. Information is

available to all free of cost. There is no investor large enough to influence themarket price of securities.

(2) There are no transactional costs. It means securities can be bought and soldwithout paying any brokerage or other expenses.

(3) There are no flotation costs. Capital can be raised without incurring anycosts like advertisement, brokerage etc.

(4) No taxes exist or there is no difference in tax rates applicable to dividendsand capital gains.

(5) The investment policy of the firm is fixed and does not change. So the

financing of investment programme through retained earnings does notchange the business risk and there is no change in required rate of return.

(6) There is no uncertainty about the future investments and profits of the firm.So the investors are able to predict future prices and dividends with certainty.(This assumption was later dropped by MM).


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(MM) Crux of the Argument

The crux of the MM position on the irrelevance ofdividend is the arbitrage argument.

The arbitrage process involves a switching and balancing

operation. Arbitrage refers to entering simultaneouslyinto two transactions which exactly balance orcompletely offset each other.

The two transaction here are the acts of paying out

dividends and raising external funds-either through thesale of new shares or raising additional loans-to financeinvestment programmes.


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(MM) Crux of the Argument

When dividends are paid to the shareholders, the market priceof the shares will decrease. What is gained by the investors asa result of increased dividends will be neutralized completelyby the reduction in the market value of the shares.

The terminal value before and after the payment of dividendwould be identical.

The investors, according to Modigliani and Miller, would,therefore, be indifferent between dividend and retention of

earnings. Since the shareholders are indifferent, it woulddepend entirely upon the expected future earnings of the firm.

This implies that the dividend decision is irrelevant.


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(MM) Proof


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(MM) Proof


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(MM) Proof


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(MM) Proof


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DividendPolicy trendsin India


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Legal aspectsof Dividends


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Dividends to be paid only out of Profits

It is necessary for a company to declare and pay dividend only out of profits forthat year arrived at after providing for depreciation in accordance with theprovisions of section 205(2) of the act.

A dividend could be declared out of profits of the company for any previousfinancial year or years arrived after providing for depreciation in accordancewith those provisions and remaining undistributed.

The dividend can also be declared out of moneys provided by the central govt.

or a state govt. for the payment of dividend in pursuance of guarantee givenby that govt.

The company is required to transfer to the reserves such percentage of itsprofits for that year not exceeding 10% in addition to providing for depreciationas required under section 205(2A) of the Act.


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Dividends are to be paid within 30 days from the date of thedeclaration

If they are not paid the company is required to transfer the unpaiddividend to unpaid account within 7 days of the expiry of the period of30 days.

The company is required to open this account in any scheduled bank asrequired under section 205-A of the Companies Act, 1956

Dividend is to be paid only to registered shareholders orto their order or their bankers

Unpaid dividend to be transferred to special dividendaccount


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Proceduralaspects ofDividends


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Procedural aspects of Dividends

1.Board Resolution2.Shareholder Approval

3.Record Date4.Dividend Payment5.Unpaid Dividend


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Tax aspects ofDividends


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Tax aspects of Dividends

With effect from financial year 2003-04,dividends income from domesticcompanies and mutual funds is exemptfrom tax in the hands of the

shareholders/investors.

However, the domestic companies will be

liable to pay dividend distribution tax atthe effective rate of 16.995% on dividendspaid after April 1, 2007.


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Thank You

Documents

Dividend Payouts Final