Dividend Payouts Final

Dividend Payouts
Shalini Rao (28)

M. Subha Pallavi (35)
Loknath Reddy (10)
DVD Ravi Kumar (09)
Eluri Arunkiran (16)
Dividends
Dividends are payments made to

stockholders from a firm's earnings,
whether those earnings were generated in
the current period or in previous periods.
Dividend Decision
One of the three basic decisions of a financial manager,

the other two being investment decision and financing
decision.
Decision as to whether the firm’s profits should be paid
as 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
Types of Theories
Dividend
Relevance
Dividend policy is very effective for any business firm as it effects the
overall value of the firm.
Dividend policy is relevant and dividend decision form a very integral

part of the investment and financing decision of the firm.
Share holders prefer current dividends & hence there is a direct

relationship between the dividend policy and the market value of the
firm.
Theories following this notion
1. Walter’s model
2. Gordon’s model
Walter’s 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 the
shareholders wealth.
Assumptions
Market value of shares is affected by the present
value 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.
Walter Model-Decisions
Walter Model-criticism
It ignores the benefit of optimal capital structure.
Assumption that ‘k’ remains constant does not

hold good in practice.
It ignores the market price is affected by many

factors.
Gordon’s 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 prefer

current dividends as against the future uncertain
capital gains.
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.
Gordon Model-Decision
If r>k>g: company should distribute less dividend and

retain high profit.
If r<k : company should distribute more profits as

dividend.
If r=k : payout ratio is not affected by retention

ratio.
Dividend Capitalization Model
Market 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 share
b=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.
Irrelevance
of
Dividends
The value of a firm is unaffected by the distribution of

dividends and is determined solely by the earning power
and risk of its assets.
Value of the firm is affected by the earning capacity of the

firm i.e., the investment policy and not the dividend
policy.
Modigliani and Miller (MM) Hypothesis
Modigliani and Miller put forward the hypothesis that

dividend is a passive variable and it does not influence the
share valuation. Thus M-M model is known as Dividend
Irrelevance Model.
Modigliani and Miller provide the most comprehensive

argument that the investment decision of the firm, the
dividend payout ratio is a mere detail and that it does not
affect the wealth of owners. They argue that the value of
the firm is determined solely by the earning power of the
firm and not its pattern of distribution of earnings that will
influence the value of shares.

(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 the
market price of securities.

(2) There are no transactional costs. It means securities can be bought and sold
without paying any brokerage or other expenses.

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

(4) No taxes exist or there is no difference in tax rates applicable to dividends
and 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 not
change 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).
(MM) Crux of the Argument
The crux of the MM position on the irrelevance of
dividend is the arbitrage argument.
The arbitrage process involves a switching and balancing

operation. Arbitrage refers to entering simultaneously
into two transactions which exactly balance or
completely offset each other.
The two transaction here are the acts of paying out

dividends and raising external funds-either through the
sale of new shares or raising additional loans-to finance
investment programmes.
(MM) Crux of the Argument
When dividends are paid to the shareholders, the market price
of the shares will decrease. What is gained by the investors as
a result of increased dividends will be neutralized completely
by the reduction in the market value of the shares.
The terminal value before and after the payment of dividend

would 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 would
depend entirely upon the expected future earnings of the
firm.
This implies that the dividend decision is irrelevant.

(MM) Proof
(MM) Proof
(MM) Proof
(MM) Proof
Dividend
Policy trends
in India
Legal aspects
of Dividends
Dividends to be paid only out of Profits

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

A dividend could be declared out of profits of the company for any previous
financial year or years arrived after providing for depreciation in accordance
with 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 given
by that govt.

The company is required to transfer to the reserves such percentage of its
profits for that year not exceeding 10% in addition to providing for depreciation
as required under section 205(2A) of the Act.
Unpaid dividend to be transferred to special dividend
account
Dividends are to be paid within 30 days from the date of the

declaration

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

The company is required to open this account in any scheduled bank as
required under section 205-A of the Companies Act, 1956
Dividend is to be paid only to registered shareholders or to

their order or their bankers

Procedural
aspects of
Dividends
Procedural aspects of Dividends
1.Board Resolution
2.Shareholder Approval
3.Record Date
4.Dividend Payment
5.Unpaid Dividend
Tax aspects of
Dividends
Tax aspects of Dividends
With effect from financial year 2003-04,
dividends income from domestic
companies and mutual funds is exempt
from tax in the hands of the
shareholders/investors.
However, the domestic companies will be

liable to pay dividend distribution tax at
the effective rate of 16.995% on dividends
paid after April 1, 2007.
Thank You

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Dividend Payouts

Shalini Rao (28)

Dividends are payments made to

One of the three basic decisions of a financial manager,

Objective: 1. maximize wealth of shareholders,

Dividend policy is relevant and dividend decision form a very integral

Share holders prefer current dividends & hence there is a direct

Together, the cost of capital (k) and rate of return (r)

Retained earnings affect future

The firm has very and infinite life

All earnings are either distributed as dividends or

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

It ignores the benefit of optimal capital structure.

Assumption that ‘k’ remains constant does not

It ignores the market price is affected by many

Dividend policy is relevant to the value of the

Also known as the “bird on hand” argument.

Dividend policy is relevant as the investors prefer

1. The firm is an all equity firm.

If r>k>g: company should distribute less dividend and

If r<k : company should distribute more profits as

If r=k : payout ratio is not affected by retention

The value of a firm is unaffected by the distribution of

Value of the firm is affected by the earning capacity of the

Modigliani and Miller put forward the hypothesis that

Modigliani and Miller provide the most comprehensive

The arbitrage process involves a switching and balancing

The two transaction here are the acts of paying out

The terminal value before and after the payment of dividend

The investors, according to Modigliani and Miller, would,

This implies that the dividend decision is irrelevant.

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

Dividend is to be paid only to registered shareholders or to

However, the domestic companies will be

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