Dividend Decisions By Heena Malhotra

Residual Approachh 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 Walter Model Walter approach is based on the following assumptions: .All investments proposals of the firm are to be financed through retained earnings only ' rate of return & 'K cost of capital are constant . Perfect capital markets: The firm operates in a market in which all investors are rational and information is freely available to all. No taxes or no tax discrimination between dividend income and capital appreciation (capital gain): This assumption is necessary for the universal applicability of the theory, since, the tax rates or provisions to tax income may be different in different countries .No floatation or transaction cost: Similarly, these costs may differ country to country or market to market. The firm has perpetual life By Heena Malhotra

IRR, K and optimum payout As we know Walter approach consider two factors, following is the conclusion of Walter model Condition Correlation between Optimum d of r vs K Size of Dividend and payout ratio Company Market Price of share Negative No correlation Every payout ratio is Growth Zero Constant optimum Decline Positive 100% By Heena Malhotra

The relationship between dividend and share price based on Walter's formula is shown below: Market Price (P)- DE-DxrK Where, P- Market Price of the share. E- Earnings per share D Dividend per share. K- Cost of equity/ rate of capitalization/ discount rate. r Internal rate of return/return on investment By Heena Malhotra

o Walter has developed a mathematical equation to ascertain the market price of a share which enable a firm to arrive at the appropriate dividend decision. His equation is based on the following share valuation model. Ke-g By Heena Malhotra

Advantages of Walter Model 1. The formula is simple to understand and easy to compute. 2. It can envisage different possible market prices in different situations and considers internal rate of return, market capitalisation rate and dividend payout ratio in the determination of market value of shares. Limitations of Walter Model The formula does not consider all the factors affecting dividend policy and share prices. Moreover, determination of market capitalisation rate is difficult. Further, the formula ignores such factors as taxation, various legal and contractual obligations, management policy and attitude towards dividend policy and so on. 1. 2. 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

Dividend Decisions 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's Basic Valuation Formula ke-br E-Eb ke-br D1 ke-g 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

Gordon's Revised Model That is there is a two fold assumption, viz ( investors are risk averse, and ()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. By Heena Malhotra

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

Advantages of Gordon Model 1. The dividend discount model is a useful heuristic model that relates the present stock price to the present value of its future cash flows 2. This Model is easy to understand Limitations of Gordon Model 1. The dividend discount model, depends on projections about company growth rate and future capitalization rates of the remaining cash flows, which may be difficult to calculate accurately. 2. The true intrinsic value of a stock is unknowable, By Heena Malhotra

102 lessons,

15h 6m

Enroll

1.3k

✕Download

Heena Malhotra

Believe in Conceptual Learning.

Unacademy user

Ekta Sharma

6 months ago

nice sir

0

Reply

Guruprasad

a month ago

arbitration concept plz do a lesson

0

Reply

Guruprasad

a month ago

arbitrage concept clear plz

0

Reply

Guruprasad

a month ago

arbitrage concept clear plz

0

Reply

Guruprasad

a month ago

arbitration

0

Reply

Nitin

2 months ago

great explanation mam and clear voice

0

Reply