Dividend Decision

2104 Words9 Pages
Financial Management

Unit 15

Unit 15
Structure 15.1 Introduction 15.2 Traditional Approach 15.3 Dividend Relevance Model 15.3.1 15.3.2 Walter Model Gordon’s Dividend Capitalization Model

Dividend Decision

15.4 Dividend Irrelevance Theory: Miller and Modigliani Model 15.5 Stability of Dividends 15.6 Forms of Dividends 15.7 Stock Split 15.8 Summary Terminal Questions Answers to SAQs and TQs 15.1 Introduction Dividends are that portion of a firm’s net earnings paid to the shareholders. Preference shareholders are entitled to a fixed rate of dividend irrespective of the firm’s earnings. Equity holders’ dividends fluctuate year after year. It depends on what portion of earnings is to be
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Symbolically, P = [m (D+E/3)] Where P is the market price, M is the multiplier, D is dividend per share, E is Earnings per share. Drawbacks of the Traditional Approach: As per this approach, there is a direct relationship between P/E ratios and dividend pay­out ratio. High dividend pay­out ratio will increase the P/E ratio and low dividend pay­out ratio will decrease the P/E ratio. This may not always be true. A company’s share prices may rise in spite of low dividends due to other factors. 15.3 Dividend Relevance Model Under this section we examine two theories – Walter Model and Gordon Model. 15.3.1 Walter Model Prof. James E. Walter considers dividend pay­outs are relevant and have a bearing on the share prices of the firm. He further states, investment policies of a firm cannot be separated from its dividend policy and both are inter­linked. The choice of an appropriate dividend policy affects the value of the firm. His model clearly establishes a relationship between the firm’s rate of return r, its cost of capital k, to give a dividend policy that maximizes shareholders’ wealth. The firm
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