SCHOOL OF MANAGEMENT

MASTER IN BUSINESS ADMINISTRATION (MBA)

SUBMITTED BY;

ROHAN DEEPAK NIKAM

ROLL NO. 013096

MBA FINANCE 2

2013-2015

SUBJECT: CORPORATE FINANCE

AVAILABILITY OF DIVIDEND POLICY IN CORPORATE

SUBMITTED TO: PROF. NEETU SHARMA

MBA FINANCE-II

MEANING OF DIVIDEND POLICY

A dividend refers to that portion of a firm's net earnings which are paid to shareholders. Dividends are paid either in cash or stock. Since dividends are distributed out of the profits, the alternative to the payment of dividends is the retention of earnings. The retained earnings constitute an important source of financing the investment requirements of the firm. There is inverse relationship between retained earnings and cash dividends. More dividends result in smaller retentions where as lesser dividend results in larger retentions. Thus, dividends and retained earnings are competitive and conflicting.

Dividend decisions refer to the decisions regarding the division of net earnings to the dividend and retained earnings. A firm can distribute all of its earnings to the shareholders as dividends or can retain all of its earnings for reinvestment as retained earnings or can distribute a part of earnings as dividend and retain the balance for re-investment purpose.

Dividend decision is a major financial decision in the sense that a firm has to choose between distributing profits to the shareholders and ploughing back them into the business. The selection would be influenced by the effect on the objective of financial management of maximizing shareholder's wealth.

Given the objective of financial management of maximizing shareholder's wealth, the firm should be guided by the consideration as which alternative use of net earnings is consistent with the goal of wealth maximization. If paying dividends to shareholders will maximize the wealth of shareholder, the firm would be advised to use earnings for paying dividends to shareholders. The firm would be advised to retain the earnings if retaining earning will end to the maximization of wealth. Thus, optimal dividend policy is one which leads to maximization of wealth of owners.

FACTORS AFFECTING DIVIDEND POLICY OF A FIRM

A firm's dividend policy is influenced by the large numbers of factors. Some factors affect the amount of dividend and some factors affect types of dividend. The following are the some major factors which influence the dividend policy of the firm.

1. Legal requirements

There is no legal compulsion on the part of a company to distribute dividend. However, there certain condition imposed by law regarding the way dividend is distributed. Basically there are three rules relating to dividend payments. They are the net profit rule, the capital impairment rule and insolvency rule.

2. Firm's liquidity position

Dividend payout is also affected by firm's liquidity position. In spite of sufficient retained earnings, the firm may not be able to pay cash dividend if the earnings are not held in cash.

3. Repayment need

A firm uses several forms of debt financing to meet its investment needs. These debt must be repaid at the maturity. If the firm has to retain its profits for the purpose of repaying debt, the dividend payment capacity reduces.

4. Expected rate of return

If a firm has relatively higher expected rate of return on the new investment, the firm prefers to retain the earnings for reinvestment rather than distributing cash dividend.

5. Stability of earning

If a firm has relatively stable earnings, it is more likely to pay relatively larger dividend than a firm with relatively fluctuating earnings.

6. Shareholder's individual tax situation

For a closely held company, stockholders prefer relatively lower cash dividend because of higher tax to be paid on dividend income. The stockholders in higher personal tax bracket prefer capital gain rather than dividend gains.

7. Access to the capital market

If a firm has easy access to capital markets in raising additional financing, it does not require more retained earnings. So a firm's dividend payment capacity becomes high.

TYPES OF DIVIDEND POLICY

There are basically 4 types of dividend policy. Let us discuss them on by one:

1) Regular dividend policy: in this type of dividend policy the investors get dividend at usual rate. Here the investors are generally retired persons or weaker section of the society who want to get regular income. This type of dividend payment can be maintained only if the company has regular earning.Merits of Regular dividend policy:

It helps in creating confidence among the shareholders. It stabilizes the market value of shares. It helps in marinating the goodwill of the company. It helps in giving regular income to the shareholders.

2) Stable dividend policy: here the payment of certain sum of money is regularly paid to the shareholders. It is of three types:

a) Constant dividend per share: here reserve fund is created to pay fixed amount of dividend in the year when the earning of the company is not enough. It is suitable for the firms having stable earning.

b) Constant payout ratio: it means the payment of fixed percentage of earning as dividend every year.

c) Stable rupee dividend + extra dividend: it means the payment of low dividend per share constantly + extra dividend in the year when the company earns high profit. Merits of stable dividend policy:

It helps in creating confidence among the shareholders. It stabilizes the market value of shares. It helps in marinating the goodwill of the company. It helps in giving regular income to the shareholders.

3) Irregular dividend: as the name suggests here the company does not pay regular dividend to the shareholders. The company uses this practice due to following reasons: Due to uncertain earning of the company. Due to lack of liquid resources. The company sometime afraid of giving regular dividend. Due to not so much successful business.

4) No dividend: the company may use this type of dividend policy due to requirement of funds for the growth of the company or for the working capital requirement.

FORMS OF DIVIDEND

CASH DIVIDEND

When dividend is distributed to shareholders in cash out of the earnings of the company, it is called cash dividend. When cash dividend is distributed, both total assets and net worth of the company decrease. Total assets decrease as cash decreases and net wath decreases as retained earnings decrease. The market price per share also decreases in most cases by the amount of cash dividend distributed.

STOCK DIVIDEND/BONUS SHARES

Stock dividend refers to the dividends paid to the existing stockholders in the form of additional shares of common stock. It represents a distribution of additional shares to existing shareholder. Stock dividend increases the number of outstanding shares of the firm's stock. It involves simply an accounting entry transfer from retained earnings account to the common stock and paid in capital accounts. Due to stock dividend, retained earnings decrease, common stock and paid in capital increase. The stock dividend does not affect the equity position of stockholders. Market price per share and earning per share after stock dividend will decrease.

STOCK SPLIT

A stock split is a method to reduce the marker price per share by giving certain number of share for one old share. Due to stock split, number of outstanding shares increase and par value and marker price of the stock decrease. A stock split affects only the par value, market value and the number of outstanding shares. However, net worth of the company remains unaltered.

With a stock split, shareholder's equity account does not change, but the par value per share changes. The earnings per share will be diluted and marker price per share fall proportionately with a stock split. But, the total value of the holdings of a shareholder remains unaffected by a stock split.

REVERSE STOCK SPLIT

Reverse stock split is method used to raise marker price of a firm's stock by exchanging certain number of outstanding shares for one new share of stock. Due to reverse stock split, number of outstanding shares decreases, par value of the shares increases and marker price per share also increases. However, total net worth of the company remains unchanged. Reverse stock split is used to stop the marker price per share below a certain level. The reverse split is generally an indication of financial difficulty and is, therefore, intended to increase the marker price per share.

REPURCHASE OF STOCK

Stock repurchase is method in which a firm buys back shares of its own stock, there by decreasing shares outstanding, increasing earnings per share, and, often increasing the stock price. It is an alternative to cash dividends. In a stock repurchase, the company pays cash to repurchase shares from its shareholders. These shares are usually kept in the company's treasury and then resold when the company needs money.

If a firm has excess cash, it may purchase its own stock leaving fewer shares outstanding, increasing the earning per share and increasing the stock price. It may be an alternative to paying cash dividends. The benefits to the shareholders are the same under cash dividend and stock repurchase. In the absence of personal income taxes and transaction costs, both cash dividend and stock repurchase have no any difference to shareholders. Capital gain arising from repurchase should equal the dividend otherwise would have been paid.

DIVIDEND POLICY OF 5 IT COMPANIES

1. TATA CONSULTANCY SERVICES (TCS) Dividend Summary

For the year ending March 2013, Tata Consultancy Services has declared an equity dividend of 2200.00% amounting to Rs 22 per share. At the current share price of Rs 2000.85 this result in a dividend yield of 1.1%.

2. WIPRO Dividend Summary

For the year ending March 2013, Wipro has declared an equity dividend of 350.00% amounting to Rs 7 per share. At the current share price of Rs 477.95 this result in a dividend yield of 1.46%.

3. INFOSYS Dividend Summary

For the year ending March 2013, Infosys has declared an equity dividend of 840.00% amounting to Rs 42 per share. At the current share price of Rs 3347.60 this result in a dividend yield of 1.25%.

4. HCL TECHNOLOGIES Dividend Summary

For the year ending June 2012, HCL Technologies has declared an equity dividend of 600.00% amounting to Rs 12 per share. At the current share price of Rs 1050.25 this result in a dividend yield of 1.14%.

5. LARSEN & TOUBRO INFOTECH Dividend Summary

For the year ending March 2013, Larsen and Toubro has declared an equity dividend of 925.00% amounting to Rs 18.5 per share. At the current share price of Rs 964.15 this result in a dividend yield of 1.92%.

SUMMARY

Dividend Policy is concerned with the decisions regarding division of net income to the dividend and retained earnings. The firm should determine optimum dividend policy which leads the firm to stockholders wealth maximization. A company can adopt either residual dividend policy or stable dividend policy. Three alternative stable dividend policies are constant dividend per share, constant dividend pay out and regular plus extra dividend policy.

A firm's dividend payment procedures start with determining the declaration date on which board of directors declare dividends to be paid, the holders of record date and payment date.

A firm's dividend policy is influenced by a large no. of factors like legal requirements, desire of shareholders, liquidity position; need to repay debt, desire of control, rate of business expansion, access to capital market, tax position of shareholders, restrictions in debt contracts etc.

Cash dividend is the dividend, which is distributed to shareholders in cash. Due to cash dividend, total assets as well as net worth decrease as cash and retained earnings decrease. The market price of share also decreases by the amount of cash dividend distributed.

A stock dividend refers to the dividend distributed to existing shareholders in the form of additional shares rather than in cash. Due to stock dividend, no. of outstanding shares increases, Common stock and paid in capital increases and retained earnings decrease. However, net worth remains unchanged.

Stock split increases the number of outstanding shares with a proportionate decrease in par value. Reverse stock split decreases the number of shares outstanding with a proportionate increase in par value. With a stock split and reverse stock split, shareholder's equity remains unchanged.

In a stock repurchase, a firm buys back some of its outstanding shares, thereby decreasing number of shares, increasing earning per share and marker price. It is an alternative to paying cash dividend.