Theories Of Dividend Policy

The questions that follow and the article Comparing the Accuracy and Explainability of Dividend, Free Cash Flow, and Abnormal Earnings Equity Value Estimates will inform your completion of Milestone Three. An understanding of the models in this assignment will assist you in hypothesizing the incremental impact of a new investment project for the company. The understanding of these models will contribute to your ability to look toward the future when considering the direction of an organization. This activity is worth a total of 75 points. See the distribution of points listed before each question.

When a company decides to pay dividends, it has to be careful on how much it will be given to the shareholders. It is of no use to pay shareholders dividends

George C. Philippatos and William W. Sihler, 'Models of Dividend Policy', Financial Management (Allyn and Bacon), 228-229

When a company generates a profit, management has one of two choices: They can either pay it out to shareholders as a cash dividend, or retain the earnings and reinvest them in the business.

Since the emergence of the so-called irrelevance theorem by Miller and Modigliani (1961), many corporations are puzzled about why some firms pay dividends while others do not. They were the first to study the effect of dividend policy on the market value of firms by assuming that there are no market imperfections. Miller and Modigliani (1961) proposed that divided policy chosen by a firm has no significant relationship in as far as the market valuation of the firm is concerned. They went further to explain that; the shareholders wealth remains unchanged irrespective of how the firm distributes it income because the firms’ value is rather determined by their investment policies and the earning power of its assets. They further stated that the opportunity to earn abnormal returns in the market does not exist, that is, owners are entitled to the normal market returns adjusted for risk.

Dividend Policy | -Pay out dividend to shareholders in profitable period | -100% plowback to reinvest in the business |

A high dividend payout policy reduces the rate of growth in earnings, g = br. For any rate of return on investment (r), the larger the payout ratio (the smaller the value of b), the slower the rate of growth. Lumber firms in general (Georgia Atlantic is an exception) have approximately a 35 percent payout ratio. Since the other companies have, on average, been growing at a rate of about 7 percent annually over the last twenty years, versus an average growth rate of 2.47 percent for Georgia Atlantic, it is clear that Georgia Atlantic's ROE on investment is substantially below the industry average.

In practice, dividend policy will be affected by taxes as tax rates for different categories of investors will differ. Also, a firm’s dividend policy is perceived by the financial markets to be a signaling mechanism. A cut back in dividends may signify that the firm perceives tough

The fact that shareholders are taxed twice through this repayment methodology infers that dividends are not their repayment technique of choice. Furthermore, paying out cash reserves through dividends also has the effect of both reducing the company’s assets and also inhibited the company’s ability to fund future growth as Dividends reduce the company’s retained earnings.

The standard method of calculating a stock price using the perpetual dividend growth model is done by assessing a company’s dividend one year into the future adding the future expected growth rate. The formula is written as: P0 = D1/(Ke − g), where Ke is the investor required return, D1 is next year’s dividend and g is the

18. The dividend-irrelevance proposition of Miller and Modigliani depends on the following relationship between investment policy and dividend policy. A) The level of investment does not influence or matter to the dividend decision B) Once the dividend policy is set the investment decision can be made as desired C) The investment policy is set before the dividend decision and not changed by dividend policy D) None of the above Answer: C Type: Medium Page: 425

A dividend is a usually distributed in cash form to stock holders of a corporation approved by the board of director. It may also include stock dividend or other forms of payment. A stock dividend represents a distribution of additional shares to common stockholders. Dividends are only cash payments regularly made by corporations to their stockholders.

Sourav has illustrated in the initial portion of his discussion how it is that the HPR and DDM values of his selected firms will differ, mainly as a result of the different assumptions underlying each formula. Between the HPR model’s generalized distribution assumption, and the DDM’s time-consuming need to forecast each incremental dividend to be paid, investors are faced with a dilemma when determining which model to use when valuing a firm. Valkama et al (2013) then add further complication to the matter when they raise the issue of how special dividends and stock splits can then further impact the raw inputs of these formulae, as they will therefore require special adjustments to properly accommodate the relevance of these situations. With this information in mind, I intend on further developing the relevance of the DDM from the perspective of an investor that is looking to benefit from an acquisition.

Paying dividends will reduce the available funds of the company but is a way to increase shareholder value. Increasing or decreasing of DPR spells out the standing of the company to its shareholders. Reduction or not giving dividends for a period will reduce AFN but will mean that the company is struggling to provide enough profit. Shareholders may see this as a signal that further investments for the company are riskier.

There are many theoretical and empirical results describing the decisions companies make in this area. At the same time, however, there is no generally accepted model describing payout policy. Moreover, empirical findings are often contradictory or difficult to interpret in light of the theory. In their seminal paper, Miller and Modigliani (1961) showed that under certain assumptions dividends are irrelevant; all that matters is the firm’s investment opportunities. Miller and Modigliani considered the case of perfect capital markets (no transaction costs or tax differentials, no pricing power for any of the participants, no information asymmetries or costs), rational behaviour (more wealth being preferred to less, indifference between cash payments and share value increases) and perfect certainty (future investments and profits are given). In real life, however, people seem to care about dividends. Lintner.s (1956) classical study on dividend policy suggests that dividends represent the primary and active decision variable in most situations. Lintner suggests a model of partial adjustment to a given payout rate.