DIVIDEND

 Dividend refers to the corporate net profits distributed among

shareholders.
 Dividends can be both preference dividends and equity dividends.
 Preference dividends are fixed dividends paid as a percentage every year
to the preference shareholders if net earnings are positive.
 After the payment of preference dividends, the remaining net profits are
paid or retained or both depending upon the decision taken by the
management.

DETERMINANTS OF DIVIDEND POLICY

 Dividend payout ratio
Dividend payout ratio refers to the percent of net profit to be distributed
as dividends by the firm to the shareholders. The remaining part of the
earning is held by the firm for its further growth.

DP Ratio = Dividend paid to shareholders / Net profit of the firm

Dividend policy involves the decision to pay out earnings or to retain them
for reinvestment in the firm.
The retained earnings constitute a source of finance.

 Stability of dividends
 Dividend stability refers to the payment of a certain minimum
amount of dividend regularly.
 Stability of dividend means how regular or stable is the dividend
policy of a firm over a period of time.
 Shareholders prefer stable dividends along with some growth in
those dividends.
 If a firm is able to pay dividends in such a way then the cost of shares
will increase.
 Legal and contractual constraints
Companies Act 2013, sections & instructions must be followed.
Dividend can be paid either as:
• Final Dividend that is paid after the annual general meeting of the firm
after analyzing the earnings.
• Interim Dividend that is paid in between the two Annual General Meetings
of a firm, if firm seems to generate expected profits.
Dividend is paid from the earnings of present year.
Once the dividend amount is declared, that must be paid to the
shareholders within 30 days.

 Age of the company

The age of the company also influences the dividend decision of a
company.
A newly established concern has to limit payment of dividend and retain
substantial part of earnings for financing its future growth and
development, while older companies which have established sufficient
reserves can afford to pay liberal dividends.

 Capital market considerations

The extent to which the firm has access to the capital markets, also affects
the dividend policy.
In case the firm has easy access to the capital market, it can follow a liberal
dividend policy.
If the firm has only limited access to capital markets, it is likely to adopt a
low dividend payout ratio.
Such companies rely on retained earnings as a major source of financing
for future growth.

 Inflation
With rising prices due to inflation, the funds generated from depreciation
may not be sufficient to replace obsolete equipment and machinery.
So, they may have to rely upon retained earnings as a source of fund to
replace those assets.
Thus, inflation affects dividend payout ratio in the negative side.
DIVIEND POLICY
 Dividend policy is set of guidelines a company uses to decide how much of
its earning it will pay out to shareholders.
 Dividend policy implies companies through their board of directors evolve
a defined pattern of dividend payments which has bearing on further
actions.
 Dividend paid out of profit .these could either be profit of the current year
or the accumulated profit of the past.

APPROACHES TO DIVIDEND POLICY

1. Gordon’s model
 Given by Myron Gordon S.
 Gordon’s theory on dividend policy states that company dividend payout
policy and the relationship between its rate of return (r) and cost of capital
(k) influence the market price per share of the company.
Assumptions:
• Rate of return r and cost of capital k is constant.
• Life of firm is indefinite
• Growth rate is constant
• Cost of capital greater than br
Formula for calculating market price per share:

P = [E(1-B)]/Ke-br

Where,
P = Price of share
e = Earnings per share
B = retention ratio
1-b = proportion of earning distributed as dividends
Ke = capitalization rate
Br = growth rate

• ILLUSTRATIONS:
2. Modigliani and Miller’s approach
• This approach was devised by Modigliani and Miller during 1950s.
• This suggests that the valuation of a firm is irrelevant to the capital
structure of a company. Whether a firm is highly leveraged or has lower
debt component in the financing mix, it has no bearing on the value of a
firm.
Assumptions:
 There are no taxes.
 Transaction cost for buying and selling securities as well as bankruptcy
cost is nil.
 There is a symmetry of information. This means that an investor will have
access to the same information that a corporation would and investors
would behave rationally.
 The cost of borrowing is the same for investors as well as companies.
 There is no floatation cost like underwriting commission, payment to
merchant bankers, advertisement expenses, etc.
 There is no corporate dividend tax.

Formula for calculating market price per share:

P1=Po*(1+ke)-D1

Where,
P1 = Market price of the share at the end of the period
Po = market price of share at the beginning of a period
Ke = cost of capital
D1 = dividend received at the end of the period
RATIO ANALYSIS
Ratio analysis: An analytical technique that typically involves a comparison of
the relationship between two financial items.
 Objectives of ratio analysis:
• Standardize financial information for comparisons
• Evaluate current operations
• Compare performance with past performance
• Compare performance against other firms or industry standards
• Study the efficiency of operations

Types of ratios:
1. Liquidity ratios
 Current ratio = Current assets / Current liabilities
Purpose: Measures a firm’s ability to pay its current liabilities from its current
assets.
 Quick (Acid Test) Ratio = Current assets - Inventories / Current liabilities
Purpose: Measures a firm’s ability to pay its current liabilities without relying on
the sale of its inventory.
2. Asset management ratio
 The Inventory Turnover Ratio= Sales/ Inventory.
Purpose: Indicates the number of times that a firm sells its inventory each year.

 The Fixed Assets Turnover Ratio= Sales/ Net Fixed Assets

Purpose: to measure how effectively the firm uses its plant and equipment to
generate sales.

 Total Asset Turnover Ratio= Sales/ Total Assets

Purpose: Measure efficiency of total assets for the company as a whole or for a
division of the firm.
3. Profitability ratio
 Profit Margin on Sales = Net Income/ Sales
Purpose: Indicates the percentage of each sales dollar that contributes to net
income.
 Return on Assets (ROA) = Net Income/ Total Assets
Purpose: Measures the rate of return a firm realizes on its investment in assets.
 Return on Common Equity (ROE) = Net Income/ Common Equity
Purpose: Measures the rate of return on a firm’s stockholders’ equity.

TREND ANALYSIS
 The study of percentage changes in financial statement items over a
period of time.
 Trend analysis provides a simple forecasting method.
 Used to estimate the likelihood of improvement or deterioration in its
financial conditions.