Dividend Decisions By Heena Malhotra

Irrelevance Theory (Dividend is irrelevant) M.M. Approach Theories of Dividend Walter Model Relevance Theory (Dividend is relevant) Gordon Model By Heena Malhotra

Assumptions of Gordon Model This model is based on the following assumptions: Firm is an all equity firm i.e. no debt IRR will remain constant, because change of IRR will change the growth rate and consequently the value will be affected. Hence this assumption is necessary. .Ke will remains constant, because change in discount rate will affect the present value. .Retention ratio (b), once decide upon, is constant ie. constant dividend payout ratio will be followed. .Growth rate (g- br) is also constant, since retention ratio and IRR will remain unchanged and growth, which is the function of these two variable will remain unaffected. Ke> g, this assumption is necessary and based on the principles of series of sum of geometric progression for 'n' number of years .All investment proposals of the firm are to be financed through retained earnings only By Heena Malhotra

Gordon Model (Dividend Discount Model) It is financial model that values shares at the discounted value of the future dividend payments. Under this model, the price a share will be traded is calculated by the NPV of all expected future dividend payment discounted by an appropriate risk- adjusted rate. The dividend discount model price is the intrinsic value of the stock i.e Intrinsic value Sum of PV of Future cash flows Intrinsic value = Sum of PV of Dividends + PV of Stock Sale Price Stock Intrinsic Value 2 By Heena Malhotra

Gordon's Basic Valuation Formula ke-br E-Eb ke-br D1 ke-g By Heena Malhotra

Gordon's Basic Valuation Formula o y- E(1-b) E-Eb D1 ke- br D1 o V= By Heena Malhotra

The relationship between dividend and share price on the basis of Gordon's formula is shown as: Market price per share y=1 ,9) ke -g Where, VEMarket price per share (ex-dividend) do Current year dividend g -Constant annual growth rate of dividends K.-Cost of equity capital (expected rate of return) The formula given by Gordon shows that when the rate of return is greater than the discount rate, the price per share increases as the dividend ratio decreases and if the return is less than discount rate it is vice-versa. The price per share remains unchanged where the rate of return and discount rate are equal. By Heena Malhotra

Gordon's Revised Model The basic assumption in Gordon's Basic Valuation Model that cost of capital (k) remains constant for a firm is not true in practice. Gordon revised his basic model to consider risk and uncertainty. In revised model, he suggested that even where r- k, dividend policy affects the value of shares on account of uncertainty of future, shareholders discount future dividends at a higher rate than they discount near dividends. By Heena Malhotra

That is there is a two fold assumption,viz () investors are risk averse, and (i) they put a a premium on a certain return and discount / penalise uncertain returns. Because the investors are rational and they want to avoid risk, they prefer near dividends than future dividends This argument is described as bird- in-the hand argument,i,e. the value of a rupee of dividend income is more than the value of rupee of capital gain. Thus, if dividend policy is considered in the context of uncertainty, the cost of capital cannot be assumed to be constant and so firm should set a high dividend payout ratio and offer a high dividend yield in order to minimise its cost of capital.

There can be three possible situations: Dividend Discount Model Zero Growth Constant Growth Variable Growth By Heena Malhotra

Irrelevance Theory (Dividend is irrelevant) M.M. Approach Theories of Dividend Walter Model Relevance Theory (Dividend is relevant) Gordon Model By Heena Malhotra

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Knowledge Seeker

9 months ago

plz guide me... mene first topic yehi liya hai preparation ke liye

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Vishal

9 months ago

Sath bnaye rakho bhai...bhot kuch kra dunga

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9 months ago

k..

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9 months ago

sir u r doing fantastic job.. mene bahut pehele hi apke course ki rating kr de the

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9 months ago

aaj new course aaya h uski ratingreview krdo

Rambabu undabatala

a year ago

mam is their any english version please posted the videos

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Janak Chauhan

a year ago

nice video maam

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