Empirical Research report by:-

1. ABDUL RAZZAK CHOUDHARY -2017185

2. TEJAS PATIL-2017221
3. MUKADDAS PINJARI-2017222

Abstract- The purpose of this study is to examine the relationship between

dividend pay-out and corporate profitability.Three companies were taken from the
listed companies in National Stock Exchange (NSE) under the Auto 2 & 3
wheelers industry in India. Secondary data for the period of 2015 to 2017 was used
for this study based on financial statement. The objective of this study is to find out
the impact of dividend payout on corporate profitability in India.
Introduction
Dividend policy refers to the payout policy that a firm follows in determining the
size and pattern of cash distributions to shareholders over time. The Board of
Directors (BOD) of the company frames dividend policy in order to make
decisions of how much earnings distributed among the shareholders as the reward
for making investment and taking risk in certain company and how much retained
within the company as retained earnings. Dividend policy is an essential area of
research in corporate finance. Under real world conditions, determining an
appropriate payout policy often involves a difficult choice because of the need to
balance many potentially conflicting forces. According to conventional wisdom,
paying dividend affects both shareholders wealth and the firm’s ability to retain
earnings to exploit growth opportunities. Because investment, financing, and
dividend decisions are interrelated (Pruitt & Gitman, 1991), management cannot
consider dividend policy in isolation from these other decisions. In addition may
investors view dividend policy as important because the supply cash to firm with
the expectation of eventually receiving cash in return.

How does dividend affect profitability?

A dividend is a distribution to shareholders of retained earnings that a company has
already created through its profit-making activities. Thus, a dividend is not an
expense, and so it does not reduce a company's profits. Because a dividend has no
impact on profits, it does not appear on the income statement. Instead, it first
appears as a liability on the balance sheet, when the board of directors declares a
dividend. Then, after the company pays the dividend, it still only has an impact on
the balance sheet, where the amount in the retained earnings line item is reduced
(as well as the amount of cash, assuming that the dividend is paid in cash).
The only way in which a dividend might reduce profits is from the perspective
of future profits - paying out large dividends might starve a company of the cash
that it needs to fund future growth, though only if the profits from the future
growth exceed the company's cost of capital. In other cases, where a company
simply has excess cash for which it cannot find a use, the distribution of that cash
as dividends should not have any impact even on its future profit potential.
One area in which dividends may have a small impact on profits is that the cash
could otherwise have been invested to generate interest income. Once the cash is
paid out to investors, the opportunity to generate interest income is lost.
Dividends are most commonly issued by established firms that do not have to re-
invest a large part of their cash flow back into their operations.

Theories

Some of the major different theories of dividend in financial management are as

follows: 1. Walter’s model 2. Gordon’s model 3. Modigliani and Miller’s
hypothesis.
On the relationship between dividend and the value of the firm different theories
have been advanced.

They are as follows:

1. Walter’s model
2. Gordon’s model
3. Modigliani and Miller’s hypothesis

1. Walter’s model:
Professor James E. Walterargues that the choice of dividend policies almost always
affects the value of the enterprise. His model shows clearly the importance of the
relationship between the firm’s internal rate of return (r) and its cost of capital (k)
in determining the dividend policy that will maximize the wealth of shareholders.

Walter’s model is based on the following assumptions:

1. The firm finances all investment through retained earnings; that is debt or new
equity is not issued;
2. The firm’s internal rate of return (r), and its cost of capital (k) are constant;
3. All earnings are either distributed as dividend or reinvested internally
immediately.
4. Beginning earnings and dividends never change. The values of the earnings per
share (E), and the divided per share (D) may be changed in the model to determine
results, but any given values of E and D are assumed to remain constant forever in
determining a given value.

Walter’s formula to determine the market price per share (P) is as follows:
P = D/K +r(E-D)/K/K

2. Gordon’s Model:
One very popular model explicitly relating the market value of the firm to dividend
policy is developed by Myron Gordon.
Assumptions:
Gordon’s model is based on the following assumptions.
1. The firm is an all Equity firm
2. No external financing is available
3. The internal rate of return (r) of the firm is constant.
4. The appropriate discount rate (K) of the firm remains constant.
5. The firm and its stream of earnings are perpetual
6. The corporate taxes do not exist.
7. The retention ratio (b), once decided upon, is constant. Thus, the growth rate (g)
= br is constant forever.
8. K > br = g if this condition is not fulfilled, we cannot get a meaningful value for
the share.
According to Gordon’s dividend capitalisation model, the market value of a share
(Po) is equal to the present value of an infinite stream of dividends to be received
by the share. Thus:

3. Modigliani and Miller’s hypothesis:

According to Modigliani and Miller (M-M), dividend policy of a firm is irrelevant
as it does not affect the wealth of the shareholders. They argue that the value of the
firm depends on the firm’s earnings which result from its investment policy.
Thus, when investment decision of the firm is given, dividend decision the split of
earnings between dividends and retained earnings is of no significance in
determining the value of the firm. M – M’s hypothesis of irrelevance is based on
the following assumptions.
1. The firm operates in perfect capital market
2. Taxes do not exist
3. The firm has a fixed investment policy
4. Risk of uncertainty does not exist. That is, investors are able to forecast future
prices and dividends with certainty and one discount rate is appropriate for all
securities and all time periods. Thus, r = K = Kt for all t.
Under M – M assumptions, r will be equal to the discount rate and identical for all
shares. As a result, the price of each share must adjust so that the rate of return,
which is composed of the rate of dividends and capital gains, on every share will
be equal to the discount rate and be identical for all shares.
Thus, the rate of return for a share held for one year may be calculated as
follows:

Where P^ is the market or purchase price per share at time 0, P, is the market price
per share at time 1 and D is dividend per share at time 1. As hypothesised by M –
M, r should be equal for all shares. If it is not so, the low-return yielding shares
will be sold by investors who will purchase the high-return yielding shares.
This process will tend to reduce the price of the low-return shares and to increase
the prices of the high-return shares. This switching will continue until the
differentials in rates of return are eliminated. This discount rate will also be equal
for all firms under the M-M assumption since there are no risk differences.
From the above M-M fundamental principle we can derive their valuation model as
follows:

Multiplying both sides of equation by the number of shares outstanding (n), we

obtain the value of the firm if no new financing exists.

If the firm sells m number of new shares at time 1 at a price of P^, the value of the
firm at time 0 will be

The above equation of M – M valuation allows for the issuance of new shares,
unlike Walter’s and Gordon’s models. Consequently, a firm can pay dividends and
raise funds to undertake the optimum investment policy. Thus, dividend and
investment policies are not confounded in M – M model, like waiter’s and
Gordon’s models.
Methods

Following studies shows the analysis of the Auto 2 & 3 wheelers industry for the
year 2015 to 2017.We have calculated the dividend yield of all the 3 companies
and taken the parameters of dividend per share, market price, and Net profit and
shown the correlation between net profit and the dividend declared per share. The
data of 3 Auto 2 & 3 wheelers industry are as follows :

Hero Motocorp

Mar-17 Mar-16 Mar-15

DPS 85.00 72.00 60.00

Market Price 3221.95 2945.7 2639.8

Dividend Yield 2.638154 2.444241 2.272899
Net profit 3,377.12 3,132.37 2,385.64

Interpretations:
 From the above data we infer that the Hero Motocorp has made a net profit
of ₹ 2385.64 in the year 2015 and thus the dividend declared per share by
the company was ₹ 60
 The company net profit increased to ₹ 3132.37 and therefore the dividend
declared per share in the year 2016 also increased to ₹ 72
 In the year 2017 again the net profit increased to ₹ 3377.12 and thus there
was an increase in the dividend declared per share to ₹ 85.
 The correlation between DPS and Net profit is 0.9531(highly positive
correlated)
 Here, the dividend payout affect the profitability of the company.

Recommendation:
As we can see there is constant increase in the net profit of the company and also
the dividends declared by the company we can recommend the investors to invest
in Hero Motocorp. There is high probability of investor earning high dividends as
well as they can also get benefit from the appreciation in value of the share.

TVS Motor
 Mar-17 Mar-16 Mar-15
DPS 2.5 2.5 1.9

Market Price 430.8 322.8 263.85

Dividend Yield 0.580316 0.774473 0.720106
Net Profit 558.08 432.14 347.83

Interpretations:
 From the above data we infer that the TVS Motor has made a net profit of ₹
347.83 in the year 2015 and thus the dividend declared per share by the
company was ₹ 1.9
 The company net profit increased to ₹ 432.14 and therefore the dividend
declared per share in the year 2016 also increased to ₹ 2.5
 In the year 2017 again the net profit increased to ₹ 558.08 but the dividend
declared per share was constant to ₹ 2.5.
 The correlation between DPS and Net profit is 0.8036(highly positive
correlated)
 Here, the dividend payout affect the profitability of the company.

Recommendation:
As we can see there is increase in the net profit of the company and also the
dividends declared by the company but in the year 2017 dividend was constant in
spite of increase in net profit but there market price increased. So here again,we
can recommend the investors to invest in TVS Motor. There is high probability of
getting appreciation in value of the share but investor shouldn’t expect increase in
dividend.

Bajaj Auto
 Mar-17 Mar-16 Mar-15
DPS 5 55 50

Market Price 2805.45 2405.95 2016.6

Dividend Yield 0.178225 2.285999 2.479421
3,827.56 3,652.41 2,813.74
Net Profit

Interpretations:
 From the above data we infer that the Bajaj Auto has made a net profit of
₹ 2813.74 in the year 2015 and the dividend declared per share by the
company was ₹ 50
 The company net profit increased to ₹ 3652.41 and therefore the dividend
declared per share in the year 2016 also increased to ₹ 55
 In the year 2017 there was only marginal increase in the net profit to
₹ 3827.56 and thus there was an tremendous decrease in the dividend
declared per share to only ₹ 5.
 The correlation between DPS and Net profit is -0.5605(negatively
correlated)
 Here, the dividend payout doesn’t affect the profitability of the company.

Recommendation:
As we can see there is increase in the net profit of the company but the dividend
declared didn’t have much increase. In year 2017 the dividend declared was
decreased by ₹50 but the market price increased by 399.5. Here the company
retained the dividend and reinvested in their business. There is high probability of
getting appreciation in value of the share but investor shouldn’t expect increase in
dividend.

Conclusion:
From the data analyzed we conclude that the Hero Motocorp and TVS motor has
positive significant relationship between dividend policy and the profitability but
Bajaj Auto has negative relationship between dividend policy and the profitability.