DIVIDEND DECISIONS

• Dividend is the amount that is paid out of

earnings after taxes by the company to its
shareholders
• It is paid as the return on investment of
shareholders and cost for the company.
• Some companies pay full earnings as dividend
• Some companies doesn’t pay even single
percentage of earnings as dividend to its
shareholders
 DIVIDEND DECISIONS
• Dividend payment is done on an criteria
depending upon the decisions taken by the
board of directors
• Payment of dividend is sole discretion of the
company policy
• If companies have a strategy of merging or
acquisition or consolidation in the next
financial year, they will decide how much has
to be paid and how much has to be retained
 DIVIDEND DECISIONS
• As per SEBI policies payment of dividend is not
mandatory
• If dividend is not paid to the shareholders they
may sell their stake and invest in other company.
• So company has to balance between the concept
of payment of dividend and retention of earnings
• Any decision taken will have a impact on the value
of the firm
 DIVIDEND DECISIONS
• If full amount of earnings are paid as dividend
company will not have any terminal amount
for its investment
• So company has to decide on the payment
policies.
• This concept is known as DIVIDEND DECISION
 DIVIDEND DECISIONS
• Many theories have been developed stating
that payment of dividend will have a direct
impact on the value of the firm
• It means the price will have an impact
• One of the important theory is WALTER’S
Model.
• It tells that payment of dividend will have a
impact on the price of share
• It is called as relevance theory
 DIVIDEND DECISIONS
• He clearly determined that if full amount of
earnings are declared as dividend the price of
the share will have a negative impact
• If part of earnings are paid as dividend and
remaining part if it is invested for company
growth, then the price of the share will
increase and in turn the value of the company
also rises
 DIVIDEND DECISIONS
• Assumptions
• If COST OF EQUITY is less then RETURN ON
INVESTMENT the price of the share will be
maximum if the retention money is high in
percentage
 DIVIDEND DECISIONS
• Assumptions
• If COST OF EQUITY is more than RETURN ON
INVESTMENT the price of the share will be
maximum if the retention money is zero in
percentage
 DIVIDEND DECISIONS
• Assumptions
• If COST OF EQUITY is equal RETURN ON
INVESTMENT payment of dividend doesn’t
have any impact on the price.
 DIVIDEND DECISIONS
When R is greater than Ke:
R = Return on investment
Ke = cost of equity capital
• The price of the share will be maximum when
retention of earnings are high
• The price of the share will be low when
maximum amount of earnings are paid as
dividend
 DIVIDEND DECISIONS
When R is lesser than Ke:
R = Return on investment
Ke = cost of equity capital
• The price of the share will be low when
retention of earnings are minimum
• The price of the share will be high when
maximum amount of earnings are paid as in
full
 DIVIDEND DECISIONS
When R is equal to Ke:
R = Return on investment
Ke = cost of equity capital
• The price of the share will be equal at any
percentage of dividend paid or any percentage
of retention of earnings
• It doesn’t have any impact on the price of the
share.
 WALTER’S MODEL
r
D ( E  D)
Pr ice  Ke
Ke
D  Dividend paid
r return on investment
Ke  cos t of equity
E  Earning per share
 Gordon’s MODEL

E 1 b 
P
Ke  br
1. The following information is available in respect of the
rate of return on investment (r) 12% and earnings per
share Rs. 20 per share of company. Determine the value
of its shares under Gordon’s Model, assuming the
following:
Cases A B C D E F G
DP ratio 10 20 30 40 50 60 70
Retention ratio 90 80 70 60 50 40 30
Cost of equity 20 19 18 17 16 15 14
 QUESTIONS
• The following information is available for M/S
Kavitha Musicals Limited:
– Earnings per share = Rs. 4
– Rate of return on investment = 18%
– Rate of return expected by shareholders = 15%
• What will be the price per share as per
Walter’s model if the payout ratio is 40%, 50%
and 60%?
When dividend payout ratio is 40% When dividend payout ratio is 50%
r r
D ( E  D) D ( E  D)
Ke Pr ice  Ke
Pr ice 
Ke Ke
0.18 0.18
1.60  ( 4  1.60) 2 ( 4  2)
0 . 15 Pr ice  0.15
Pr ice  0.15
0.15
1.60  (1.2) ( 2.40) 2  (1.2) ( 2)
Pr ice  Pr ice 
0.15 0.15
1.60  2.88 2  2.40
Pr ice  Pr ice 
0.15
0.15
4.40
4.48 Pr ice   Rs. 29.33
Pr ice   Rs. 29.87 0.15
0.15
When dividend payout ratio is 60%
r
D ( E  D)
Pr ice  Ke
Ke
0.18
2.40  ( 4  2.40)
Pr ice  0.15
0.15
2.40  (1.2) (1.60)
Pr ice 
0.15
2.40  1.92
Pr ice 
0.15
4.32
Pr ice   Rs. 28.80
0.15
• The following information is available in
respect of a firm: Ke – 10%, EPS – Rs. 10.
Assume rate of return on investment is 15%,
8% and 10%.
Show this effect of dividend policy on the
market price of share, when dividend payout
ratio is 0%, 25%, 50%, 75% and 100% using
Walter’s model.
 When r is 15% and Ke is 10% (r < Ke)
when dividend payout is 0% When dividend payout ratio is 25%
r r
D ( E  D) D ( E  D)
Ke  Ke
Pr ice  Pr ice
Ke Ke
0.15 0.15
0 (10  0) 2.50  (10  2.50)
0.10 Pr ice  0 .10
Pr ice  0.10
0.10
0  (1.5) (10) 2.50  (1.5) (7.50)
Pr ice  Pr ice 
0.10 0.10
0  15 2.50  11 .25
Pr ice  Pr ice 
0.10
0.10
13.75
15.00 Pr ice   Rs.137.50
Pr ice   Rs.150.00 0.10
0.10
When dividend payout ratio is 50% When dividend payout ratio is 75%
r
D ( E  D)
Pr ice  Ke r
D ( E  D)
Ke Pr ice  Ke
0.15 Ke
5 (10  5) 0.15
Pr ice  0.10 7.50  (10  7.50)
0.10 Pr ice  0.10
0.10
5  (1.5) (5) 7.50  (1.5) ( 2.50)
Pr ice  Pr ice 
0.15 0.10
5  7 .5 7.50  3.75
Pr ice  Pr ice 
0.10 0.10
12.50 11 .25
Pr ice   Rs.125.00 Pr ice   Rs.112 .50
0.10 0.10

When dividend payout ratio is 100%

r
D ( E  D)
Pr ice  Ke
Ke
0.15
10  (10  10)
Pr ice  0.10
0.10
10  (1.5) (0)
Pr ice 
0.10
10  0
Pr ice 
0.109
10
Pr ice   Rs.100.00
0.10
 When r is 8% and Ke is 10% (r > Ke)
when dividend payout is 0% When dividend payout ratio is 25%
r r
D ( E  D) D ( E  D)
Ke Pr ice  Ke
Pr ice 
Ke Ke
0.08 0.08
0 (10  0) 2.50  (10  2.50)
0.10 Pr ice  0.10
Pr ice  0.10
0.10
0  (0.8) (10) 2.50  (0.8) (7.50)
Pr ice  Pr ice 
0.10 0.10
08 2.50  6
Pr ice  Pr ice 
0.10
0.10
8 .5
8.00 Pr ice   Rs. 85.00
Pr ice   Rs. 80.00 0.10
0.10
When dividend payout ratio is 50% When dividend payout ratio is 75%
r
D ( E  D)
Pr ice  Ke r
D ( E  D)
Ke Pr ice  Ke
0.08 Ke
5 (10  5) 0.08
Pr ice  0.10 7.50  (10  7.50)
0.10 Pr ice  0.10
0.10
5  (0.8) (5) 7.50  ( 0.8) ( 2.50)
Pr ice  Pr ice 
0.10 0.10
5 4 7.50  2
Pr ice  Pr ice 
0.10 0.10
9 9.50
Pr ice   Rs. 90.00 Pr ice   Rs. 95.00
0.10 0.10

When dividend payout ratio is 100%

r
D ( E  D)
Pr ice  Ke
Ke
0.08
10  (10  10)
Pr ice  0.10
0.10
10  (0.8) (0)
Pr ice 
0.10
10  0
Pr ice 
0.10
10
Pr ice   Rs.100.00
0.10
 When r is 10% and Ke is 10% (r = Ke)
when dividend payout is 0% When dividend payout ratio is 25%
r r
D ( E  D) D ( E  D)
Ke Pr ice  Ke
Pr ice 
Ke Ke
0.10 0.10
0 (10  0) 2.50  (10  2.50)
0.10 Pr ice  0.10
Pr ice  0.10
0.10
0  (1.0) (10) 2.50  (1.0) (7.50)
Pr ice  Pr ice 
0.10 0.10
0  10 2.50  7.50
Pr ice  Pr ice 
0.10
0.10
10
10.00 Pr ice   Rs.100.00
Pr ice   Rs.100.00 0.10
0.10
When dividend payout ratio is 50% When dividend payout ratio is 75%
r
D ( E  D)
Pr ice  Ke r
D ( E  D)
Ke Pr ice  Ke
0.10 Ke
5 (10  5) 0.10
Pr ice  0.10 7.50  (10  7.50)
0.10 Pr ice  0.10
0.10
5  (1) (5) 7.50  (1) ( 2.50)
Pr ice  Pr ice 
0.10 0.10
55 7.50  2.50
Pr ice  Pr ice 
0.10 0.10
10 10
Pr ice   Rs.100.00 Pr ice   Rs.100.00
0.10 0.10

When dividend payout ratio is 100%

r
D ( E  D)
Pr ice  Ke
Ke
0.10
10  (10  10)
Pr ice  0.10
0.10
10  (1) (0)
Pr ice 
0.10
10  0
Pr ice 
0.10
10
Pr ice   Rs.100.00
0.10
• The earnings per share of a company is Rs. 8
and the rate of capitalization applicable is
10%.
The company has before it an option of
adopting: i) 50%, ii) 75%, and iii) 100%
dividend payout ratio.
Compute the market price of the
company’s quoted share as per Walter’s
model if it can earn a return of; i) 15%, ii) 10%,
iii) 5% on its retained earnings.
• The earnings per share of a company is Rs. 8
and the rate of capitalization applicable is
10%.
The company has before it, an option of
adopting i) 40%, ii) 60%, and iii) 80% dividend
payout ratio.
Compute the market price of the
company’s quoted shares as per Walter’s
model if it can earn a return of; i) 12%, ii) 10%,
iii) 8% on its retained earnings.
• From the following information supplied to you,
determine the theoretical market value of equity
shares of a company as per Walter’s model:
Particulars Amount
Earnings of the company 5,00,000
Dividend paid 3,00,000
No. of shares outstanding 1,00,000
Price earning ratio 8 times
Rate of return on investment 15 %

• Are you satisfied with the current dividend policy

of the firm? If not, what should be the optimal
dividend payout ratio in this case?
• From the following information supplied to you,
determine the theoretical market value of equity
shares of a company as per Walter’s model:
Particulars Amount
Earnings of the company 15,00,000
Dividend paid 5,00,000
No. of shares outstanding 1,00,000
Price earning ratio 10 times
Rate of return on investment 15 %

• Are you satisfied with the current dividend policy

of the firm? If not, what should be the optimal
dividend payout ratio in this case?