Mutual Fund Education

Unit VI
DIVIDEND POLICY

Dividend Policy
• The return to the shareholders either by way of the dividend receipts or capital gains • It decides the Retention ratio & Pay out ratio • Earnings to be Distributed – High Vs. Low Payout • Objective – to Maximize Shareholders Return • Effects – Taxes, Investment & Financing Decision

2

A few models which studies this relationship & the dividend policies of firms are given below

• • • • •

Traditional Position Walter Model Gordon Model Miller & Modigliani Position Rational Expectations Model

Jaideep Jadhav MITSOT

3

I] Traditional Position
• Given by B Graham & DL Dodd • Clear emphasis on the relationship between the dividend & the stock market • Stock Value responds positively to higher dividends & negatively when there are low dividends

Jaideep Jadhav MITSOT

4

Expression establishes relationship between market price & dividend using a multiplier

P = m(D+E/3)
P = Market price D = Dividend E = EPS m = a Multiplier

 Wt. attached to dividends is 4 times the Wt. attached to retained earnings  The Weights provided by Graham & Dodd are based on their subjective judgments & not derived from objective, empirical analysis Jaideep Jadhav MITSOT

5

Walter Model
• • • • Assumptions Valuation Optimum Payout Ratio Criticism

Jaideep Jadhav MITSOT

6

Assumptions
• Internal Financing : Retained Earnings is only source of finance available to the firm i.e. no outside debt or additional equity • Constant Return & Cost of Capital • 100% Payout or Retention • Constant EPS & DIV • Firm has Infinite Life

Jaideep Jadhav MITSOT

7

Valuation • Market price of the share is sum of the present values of future cash dividends and capital gains

(r / k ) P (DIV / k ) (EPS – DIV) k r Internal Rate of Return k Cost of Equity Capital

Jaideep Jadhav MITSOT

Example r 0.15, 0.10, 0.08 k 0.10 EPS Rs 10 DPS 40% (0.15 / 0.1) P (4 / 0.1) (10 4) 0.1 (0.10 / 0.1) P (4 / 0.1) (10