DIVIDEND POLICY BY CA CS HARISH A MATHARIYA
98220 93220
CA CS Harish A. Mathariya 98220 93220 Yes Academy 8888 545 545
#Dividend can be paid
#What is Dividend ?
‘Dividend is the distribution of company’s profit to its Share holders’
Quarterly Half Yearly Annually
#Company have 2 choice regarding earning Interim dividend Final Dividend
#Dividend Policy:-
Retained Distribute Dividend policy determines what portion of earnings will be
paid to share holders and what portion retained in business
Reserve Dividend
#Few IMP Formulae
𝑫𝑷𝑺
1. Dividend Rate = 𝒙 𝟏𝟎𝟎
This problem does not arise in partnership/Sole prop. firm 𝑭𝒂𝒄𝒆 𝑽𝒂𝒍𝒖𝒆
(Expressed as % of face value )
But, In company management & owners are diff. person
So company have to consider dividend policy 2. Dividend per share (DPS) = Face Value X Dividend Rate
dividends policy differ from company to company 𝑫𝑷𝑺 Invertors interested in
3. Dividend yield = …………..
𝑴𝑷𝑺 this ratio
% of eraning
#Dividend can be out of 4. Dividend payout ratio =
𝑫𝑷𝑺
………….. distributed as
𝑬𝑷𝑺
dividend
𝑬𝑷𝑺
Out of previous 5. Earning yield = … … … . (Return earned by S. H
Current year profit 𝑴𝑷𝑺
year profit 1 taking P/E ratio as abase )
Or =
𝑃/𝐸 𝑟𝑎𝑡𝑖𝑜
CA CS Harish A. Mathariya 98220 93220 Yes Academy 8888 545 545 10.1
6. EPS = Earning available to equity S.H
Growth rate of dividend in yr. 2 = 12,100 – 11,000
No. of Equity shares = 10%
10,000
PAT XXX
(-) Pref. Dividend (XX) Growth rate of dividend in yr. 3 = 12,100 – 11,000
(-) Bal. XXX = 10%
11,000
(-) Tax on Pref. dividend (XX)
(=) Profit Available for ESH XXX By Formulas –
So Growth rate = Retention Ratio X ROI
𝑀𝑃𝑆 = 50% X 20% = 10%
7. P/E Ratio =
𝐸𝑃𝑆
# Imp term
8. Retention Ratio = 1 – Dividend payout ratio
• Declaration Date
• Date When dividend is declared by BOD.
9. Growth Rate = Retention Ratio X Return In Investment
(Rate @ which earning & • Last – Cumdividend
dividends are growing’s) • Date up to which shares can be bought & eligible to receive
dividend.
E.g. • Ex – dividend date:
Yr. 1 Yr. 2 Yr. 3 • Date notified by stock exchange from which shares can be
A. Op. Investment 1,00,000 1,10,000 1,21,00 bought without being eligible for dividend .
B. Profit earned 20% 20,000 22,000 24,200 • Recorded Date:
C. Dividend paid (20% of PE) 10,000 11,000 12,000 • Date on which register of member is closed & list of eligible
member to receive dividend is made up.
D. Retained earnings 50% of PE 10,000 11,000 12,100
• Payment date:
E. cl. Investments (A+D) 1,10,000 1,21,000 1,33,100 • Dividend Actually paid.
CA CS Harish A. Mathariya 98220 93220 Yes Academy 8888 545 545 10.2
#Factors affecting dividend policy: - #Approaches to Dividend policy
Based on whether dividend policy influence the value of firm/not
Internal External
(out of the organization, not YES NO
under control of organization 1. Walter’s Approach 1. Modigliani &
– Nature of Earning 2. Gordon’s model Miller Approach
(Stable/Fluctuating) 3. Radical
– Contractual obligation 4. Graham
– Need of expansion – Tax Policy Regular dividend policy :- Stable Dividend Policy
– Liquidity Position – General State of Economy • Investment get regular dividend • Certain sum of money is regular
– Cost of Financing • investment from Weaker section of paid
society • Constant dividend per share
• Can be maintained only if • Constant payout ratio
company have regular earning • Stable dividend + extra
#Dividend decision & Tax dividend
• Before introduction of dividend tax; dividend was Types of dividend
taxable in the hands of share holders (1961 to 1996) policy
• It the S.H are in high tax bracket – low dividend by
company
• If the S.H in k=low tax bracket Iregular Dividend:- No Dividend
• High dividend by company • Does not pay regular dividend
CA CS Harish A. Mathariya 98220 93220 Yes Academy 8888 545 545 10.3
#Consideration in Dividend Policy #Walters Model
Legal financial - By Prof. James E Walter
Economic nature of business - Says:- Dividend policy can influence value of firm
Existence of company type of company - Says:- Use appropriate dividend policy to increase value of
Financial needs market condition firm, which is depends on type of firm
Financial arrangement change in government
Growth firm Normal firm Declining firm
(Stable)
Types of dividend
R>Ke R = Ke R<Ke
• Optimum • Payout ratio is • Optimum
Cash Stock Bond Property Payout ratio - irrelevant (any payout ratio is
zero ratio is 100%
optimum)
Co. promise
In form of to S.H to pay In form of
In cash out of stock (Bonus dividend on other asset #Formula
PAT issue to future date (Property not D+
𝑅(𝐸−𝐷) D = Dividend Per. Share
existing S.H ) (Promise in cash) Price of Share (P) =
𝐾𝑒 E = EPS
form a bond) Ke Ke = Cost of Equity
Base :- PV of infinite annuity R = ROI
CA CS Harish A. Mathariya 98220 93220 Yes Academy 8888 545 545 10.4
#Assumptions of Walter’s Model :- #Gardon’s Model (1972)
• Says, Price of shares is the present value of future
• Firm is all equity dividend
• Firm will use only retained earning for financial • Based on assumptions that dividend grows at uniform
needs rate
• R is constant Po = Mkt price at year ‘o’
• Ke is constant 𝐸(1−𝑏) b = retention ratio
• All earnings are distributed / Immediately Po = G = growth rate
𝐾𝑒−𝑔
• Firm has infinite life ‘g = bxr’
• Earning and dividend not change
Applicability :- (same as walter’s)
#Criticisms:-
• Assumptions are not realistic (like, firms will Growth firm - Optimal pay-out ratio O
use only retained earnings)
• Constant ROI is not acceptable Stable firm - Any pay-out ratio is optimum
• Constant Ke also not realistic
Declining firm – Optimal payout ratio is 100%
Note:- E(I-b) = Dividend
CA CS Harish A. Mathariya 98220 93220 Yes Academy 8888 545 545 10.5
#Assumptions – Gordon’s model Stable Dividend Policy VS Stable D/P ratio (%)
Firm is all Equity
From will use only retained earnings to finance investment
‘R’ = Constant Investors like Investor generally do not
G = Constant this policy like this So, Amt. uncertain
B = Constant
Ke>g #Modigliani – Miller Hypothesis
Firm has infinite life
g=bXr • Dividend Irrelevance “(MM theory)
No taxes • Says, Dividend has no impact on wealth of S.H
• Value of firm determined by earnings power of firm.
# Criticism of Gordon’s model
Same as Walters Model • Manner in which earning dividend into – Retained Earning
dividend or Dividend
does not affect
#Dividend 𝐷1
Growth Model
Says, Po = Po = Mkt price now, P1=price @period end
𝐾𝑒 −𝑔 D1 + P1 D1 = Dividend @ end of yr. 1
Po - Mkt Price of share @year O ∴Po =
1 + Ke Ke = Cost equity (Expected return by SH)
D1 - Dividend @ end of year 1
Ke - Cost of Equity / capitalization rate
g – Growth rate Assumptions:-
• Existence of perfect Market with rational Investors
#IMP Points:- • NO taxes
Stable Dividend policy is preferable than fluctuating. • No floatation Cost
Wealthy S.H. not interested on dividend (they are • Fixed Investment policy of firm
interested in capital appreciation) ∴ Price as per mm} [ P.V. of D1 & P1 @ Ke ]
CA CS Harish A. Mathariya 98220 93220 Yes Academy 8888 545 545 10.6
1. Which of the following factor will affect the dividend policy of the firm? 5. Which of the following techniques does not reward shareholders for
1. Insufficiency of cash investing in a company?
2. Firms contractual obligation (a) Repurchasing company shares
3. Ratio of debt to equity (b) Offering non-pecuniary benefits
4. Business cycle considerations (c) Making a rights issue
Select the correct answer from the options given below. (d) Offering a scrip dividend
(a) 1 and 3 only
(b) 2 and 4 only 6. Forecast by analysts, retention growth model and historical growth rates
(c) 2, 3 and 4 are methods used for an –
(d) 1, 2, 3 and 4 (a) Estimate future growth
(b) Estimate option future value
2. Retained earnings are – (c) Estimate growth ratio
(a) An indication of a company's liquidity. (d) Estimate option present value
(b) The same as cash in the bank.
(c) Not important when determining dividends. 7. Historical growth rates, analysis forecasts and retention growth model are
(d) The cumulative earnings of the company after dividends. approaches to estimate:
(a) Net present value of gain
3. In retention growth model, percent of net income firms usually pay out as (b) Growth rate
shareholders dividends, is classified as - (c) Growth gain
(a) Payout ratio (d) Discounted gain
(b) Payback ratio
(c) Growth retention ratio 8. The primary goal of a publicly owned firm interested in serving its
(d) Present value of ratio stockholders should be to
(a) Maximize expected total corporate profit
4. Which of the following is an argument for the relevance of dividends? (b) Maximize expected EPS
(a) Informational content. (c) Maximize the stock price per share
(b) Reduction of uncertainty. (d) Maximize expected net income.
(c) Some investor's preference for current income.
(d) All of the above.
CA CS Harish A Mathariya 98220 93220 Yes Academy 8888 545 545 10.7
9. Which of the following would not have an influence on the optimal (a) Each investment's expected return should equal its realized return.
dividend policy? (b) Each investment's expected return should equal its required return.
(a) The possibility of accelerating or delaying investment projects. (c) Each investment should have the same realized return.
(b) A strong shareholders' preference for current income versus capital (d) All of the statements above are correct.
gains.
(c) The costs associated with selling new common stock. 13. Regular Dividend Policy means –
(d) All of the statements above can have an effect on dividend policy. (a) Investors get dividend at usual rate.
(b) Reserve fund is created to pay fixed amount of dividend.
10. A stock split will cause a change in the total amounts shown in which of the (c) Payment of low dividend per share constantly plus extra dividend in
following balance sheet accounts? the year when the company earns high profit.
(a) Cash (d) All of the above
(b) Common stock
(c) Paid-in capital 14. Modigliani and Miller argue that the dividend decision _______.
(d) None of the above (a) Is irrelevant as the value of the firm is based on the earning power of
its assets.
11. You currently own 100 shares of stock in Baba Ltd. The stock currently (b) Is relevant as the value of the firm is not based just on the earning
trades at ₹ 120 a share. The company is contemplating a 2:1 stock split. power of its assets.
Which of the following best describes your position after the proposed (c) Is irrelevant as dividends represent cash leaving the firm to
stock split takes place? shareholders, who own the firm anyway.
(a) You will have 200 shares of stock, & the stock will trade at or near ₹ (d) Is relevant as cash outflow always influences other firm decisions
120 a share.
(b) You will have 200 shares of stock, and the stock will trade at or near 15. Consider following two statements;
₹ 60 a share. I. A company with large portion of inside ownership, all of whom are
(c) You will have 100 shares of stock, and the stock will trade at or near high-income individuals.
₹ 60 a share. II. A growth company with abundance of good investment opportunities.
(d) You will have 50 shares of stock, and the stock will trade at or near ₹ For each of the company described above, would you expect it to have
60 a share. a high or low dividend payout ratio?
(a) Low dividend payout ratio for both companies
12. If markets are in equilibrium, which of the following will occur: (b) High dividend payout ratio for both companies
CA CS Harish A Mathariya 98220 93220 Yes Academy 8888 545 545 10.8
(c) Low dividend payout ratio for company mentioned in Statement (I) & (c) Stock dividend
high dividend payout ratio for, company mentioned in Statement (II) (d) Regular dividend
(d) High dividend payout ratio for company mentioned in State-ment (I)
& low dividend payout ratio for company mentioned in Statement (II) 20. The date by which a shareholder must be recorded as the share owner in
order to receive a declared dividend is called the:
16. If you are calculating market price by using Gordon's Model, increasing (a) Ex-rights date
payout ratio other things renaming the same will – (b) Ex-dividend date
(a) Increase the price per share (c) Date of record
(b) Decrease the price per share (d) Date of payment
(c) Will not have any effect on price of the share
(d) Price will remain constant. 21. The difference between the highest and lowest prices at which a stock has
sold is called the stock's:
17. As per Gordon's Model whether company adopts 5096, 8096 or any (a) Average price
other payout ratio, market price will remain same when – (b) Bid-ask spread
(a) Ke > r (c) Trading range
(b) Ke < r (d) Opening price
(c) Ke = r
(d) Ke > Rf 22. Which one following statements concerning cash dividends is correct?
A. The chief financial officer of a corporation determines whether or not
18. As per Walter's Model when R a < Rc decrease in retention ratio lead to a dividend will be paid.
(a) Increase in market price B. A dividend is not a liability of a firm until it has been declared.
(b) Decrease in market price C. If a firm has paid regular quarterly dividends in the past it is legally
(c) No change in market price obligated to continue doing so.
(d) None of the above D. Cash dividends always reduce the paid-in capital account balance
19. Which one of the following is a non-cash payment made by a firm to its
shareholders that dilute the value of each share of stock outstanding?
(a) Reverse stock split
(b) Cash distribution
CA CS Harish A Mathariya 98220 93220 Yes Academy 8888 545 545 10.9
23. Required return X Retention Ratio = ? to the Gordon Growth Model, what would the rate of earnings growth be
(a) Ke (Cost of equity) in future) Ignore tax.
(b) WACC (a) 4.2%
(c) B (Beta) (b) 7%
(d) g (Growth Rate) (c) 9.8%
(d) 14%
24. A share of common stock has just paid a dividend of ₹ 2.00. If the
expected long-run growth rate for this stock is 15 per cent, and if investors 27. DHC Ltd. is looking to purchase WIC Ltd., which has the following
require a 19 per cent rate of return, what is the price of the stock? information: Revenue ₹ 40,00,000; EBITD ₹ 9,00,000; Basic EPS ₹1.40;
(a) ₹ 57.50 Net assets ₹ 50,00,000 Dividends paid 20.50. Research has shown that
(b) ₹ 62.25 the price-earnings ratio for companies like WIC Ltd. is 9.5. Based on that
(c) ₹ 71.86 ratio, what is the value of WIC Ltd.?
(d) ₹ 64.00 (a) ₹ 23,75,000
(b) ₹ 85,50,000
25. Ali Motors recently completed a 3 for 1 stock split. Prior to the split, the (c) ₹ 50,00,000
company had 10 Million shares outstanding and its stock price was ₹ 150 (d) ₹ 66,50,000
per share. After the split, the total market value of the company's stock
equaled ₹ 1.5 Billion. What was the price of the company's stock 28. Following information is available in respect of Sober Ltd.:
following the stock split? No. of shares outstanding :1 lakh
(a) ₹ 15 Earnings per share :₹4
(b) ₹ 45 Equity capitalization rate : 12%
(c) ₹ 50 Rate of return on investment : 15%
(d) ₹ 150 Calculate Dividend payout ratio to keep share price at ₹40.
(a) 50%
26. Company Q is all equity financed. For each ₹1 of earnings, it consistently (b) 40%
pays 30 paisa in dividends and retains 70 paisa for reinvestment. It (c) 60%
expects to earn a rate of return of 14% on capital employed. According (d) 20%
CA CS Harish A Mathariya 98220 93220 Yes Academy 8888 545 545 10.10
29. A Chemical company belongs to a risk class for which P/E Ratio is 10. It and assuming no taxes, ascertain the price of the company's shares as it
currently has 50,000 equity shares selling at ₹ 200 each. The firm is is likely to prevail at the end of the year - (i) when dividend is declared;
contemplating the declaration of dividend of ₹ 16 per share at the current and (ii) when no dividend is declared.
fiscal year which has just started. Given the assumption of Modigliani- (i) (ii)
Miller, what will be the price of share at the end of the year if dividend (a) ₹ 15.0 ₹ 12.5
is declared? (b) ₹ 10.5 ₹11.5
(a) ₹ 205 (c) ₹ 11.5 ₹ 12.5
(b) ₹ 208 (d) ₹ 9.5 ₹ 11.5
(c) ₹ 204
(d) ₹ 225 32. Abhishek Steel Ltd. has one lakh equity shares outstanding which are
selling at ₹ 100 each. Its capitalization rate is 14%. The company is
30. Damodhar Ltd. has 10 lakh equity shares outstanding. Current market expecting ₹ 65 lakh income for the current year and is planning to pay
price of the shares is ₹ 150 each. The board of directors of the company dividend amounting to ₹ 4 lakh. The company wants to invest in a new
has recommended dividend of ₹ 8 per share. Rate of capitalization is project which will cost ₹ 75 lakh. It is assumed that the MM Model on
125. How many shares are to be issued as per MM Model at the end of dividend policy is applicable. Compute the number of shares to be issued
accounting year on the assumption that the net income is ₹ 2 Crore and for financing when: A. Dividend is not paid. B. Dividend amounting to ₹ 4
the investment budget is ₹ 4 Crore and dividend is declared as lakh is paid.
recommended by the directors. (a) 8,500 12,500
(a) 1,19,047 shares (b) 8,772 12,727
(b) 1,75,000 shares (c) 8,692 12,853
(c) 1,57,000 shares (d) 8,346 12,777
(d) 1,68,419 shares
33. Current price of share of X Ltd. is ₹ 60 and just paid dividend per share
31. Rama Ltd. had 1,00,000 equity shares of ₹ 10 each outstanding. Shares is ₹ 4. If the capitalization rate is 12%, what is the dividend growth rate?
are currently being quoted at par in the market. In the wake of the (a) 3%
removal of the dividend restraint, the company now intends to pay a (b) 5%
dividend of ₹ 2 per share for the current financial year. It belongs to a (c) 4%
risk class whose appropriate capitalization rate is 15%. Using MM Model (d) 6
CA CS Harish A Mathariya 98220 93220 Yes Academy 8888 545 545 10.11
Answers
1 D 2 D 3 A 4 D 5 C 6 A 7 B 8 C 9 D 10 D
11 B 12 B 13 A 14 A 15 A 16 A 17 C 18 A 19 C 20 C
21 C 22 B 23 D 24 A 25 C 26 C 27 D 28 D 29 C 30 B
31 D 32 B 33 B
CA CS Harish A Mathariya 98220 93220 Yes Academy 8888 545 545 10.8
