Pay Out Decision

8/9/2019 Pay Out Decision

1/19

Dividend Decision


2/19

OBJECTIVES OF DIVIDEND POLICY

Firms Need Funds

Shareholders Need Income Dividend policy involves the balancing of

the shareholders desire for current

dividends and the rms needs for fundsfor growth.

Obective ! "a#imi$e Shareholders %eturn.

&& Dividends can be paid out of freereserves 'past prot( only not from capital.


3/19

Relevance Vs.Irrelevance

)alter*s "odel

+ordon*s "odel

,he -ird in the and /rgument

%esidual theory of Dividend

"odigliani and "iller ypothesis


4/19

+ordon "odel

"ar0et value of a share is e1ual tothe present value of an innitestream of dividends to be received

by shareholders.


5/19

,he basic assumptions of+O%DONSmodel

,he rm has perpetual life span

,he only source of nancingavailable to the rm is retainedearnings

,he return on investment and cost ofcapital are constant throughout thelife of the rm.

,he cost of e1uity is greater than itsgrowth rate.


6/19


7/19

Interpretation

,he mar0et value of the share 2o

increases with the retention ratio b3for the rms with growth opportunityi.e. r 4 0.

,he mar0et value of the share 2o

increases with the payout ratio3 '5 !b( for declining rms with r 6 0.

,he mar0et value of the share is nota7ected by dividend policy when r 80.


8/19

DIVIDEND AND UNCERTAINTY:THE BIRD-IN-THE-HAND ARU!ENT

Investors are ris0 averse.

,hey consider distant dividends asless certain than near dividends.

,he %ate at which an investordiscounts his dividend stream from agiven rm increases with the futurityof dividend stream and hencelowering share prices.


9/19

DIVIDEND IRRELEVANCE: THE!ILLER"!ODILIANI #!!$

HYPOTHESIS /ccording to "9"3 under a perfectmar0et situation3 the dividend policy of arm is irrelevant as it does not a7ect the

value of the rm. ,hey argue that the value of the rm

depends on rm earnings which results

from its investment policy. ,hus3 wheninvestment decision of the rm is given3dividend decision is of no signicance.


10/19

,a#es on Dividend : ;apital +ains '


11/19


12/19

-onus Issue

;apitali$ation of %eserves

)hen share holders receives bonusshares they receive GNothing of Halueimmediately 'as the share price falle#actly the same proportion(.


13/19

S&)nal&n) *r+, B+nsSares

Indication of higher future prots

Future dividends may increase

;onservation of cash

2sychological value


14/19

S'+c/ S%l&'

/ share split is a method to increasethe number of outstanding sharesthrough a proportional reduction in

the par value of the share.

/ share split a7ects only the parvalue and the number of outstanding

shares the shareholders total fundsremain unaltered.


15/19

B+ns Sare vs. SareS%l&'

,he bonus issue and the share split are similare#cept for the di7erence in their accountingtreatment.

In the case of bonus shares3 the balance of thereserves and surpluses account decreases dueto a transfer to the paid9up capital and theshare premium accounts. ,he par value pershare remains una7ected.

)ith a share split3 the balance of the reserveand surplus accounts does not change3 but thepar value per share changes.


16/19

Strategic Determinants of Dividend 2olicy

Ji1uidityK 2rotable rm may not be cash rich. For a cashpoor rm it is diLcult to pay dividend as it will further

increase the cash outMow. Investment opportunityK 2ay low dividend if future

investment opportunity e#ists. /lso pay out depends on thelife cycle of the business.

/ccess to nanceK ow 1uic0ly rm able to get money from

the nance mar0et. 'the condition of the capital mar0et(.

;orporate controlK,o nance new investment if rm needsto issue e1uity it will decrease the proportion of holding ofthe e#isting share holders and dilute their proportionalsta0e.

Investors preferenceK )hat they prefer pay out or retention.It also depends on the si$e of the rm.

Dividend stabilityK ;onsistent payment of dividend.

,a#esK Dividend income is not ta#able in the hands of the

investors but capital gain ta# might be.


17/19

Survey response on Dividend decision in >.=B

A )e consider the change or growth in dividend pershare

EE.>B

E )e consider the cost of raising e#ternal capital to besmaller than the cost of cutting dividend

.?B

> )e pay dividend to attract investors 5.>B


18/19

Survey response on Dividend decision in India

P+l&c0 S'a'e,en' 1 2+s'r+n)l

0a)rees

5 Dividend change follows shift in long term earnings ?A.B

as long term target dividend pay9out ratio ?5.AB

@ Focus more on absolute level of dividend than

dividend change

E>.=B

Dividend payout ratio a7ects the mar0et value of therm

>5.EB

A Dividend provides signaling mechanism of futureprospect of the rm.

>5.EB

E )illing to rescindwithdraw dividend increase in theevent of growth opportunity

AE.?B

> ;ash dividend as residual after nancing desiredinvestment from earnings

E.=


19/19

Survey response on Dividend decision in

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Pay Out Decision