FIN722

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Dividend word:-

The word dividend is derived from Latin word dīvidendumthingtobedivided.

Definition:-

A sum of money paid regularly (typically annually) by a company to its shareholders out of its profits (or reserves)

Detail: – A dividend is a payment made by a  corporation toits  shareholders, usuallyas adistribution of  profits. When a corporation earns a profit or surplus, it can re-invest it in the business (called  retained earnings), and pay a fraction of this reinvestment as a dividend to shareholders. Distribution to shareholders can be in cash (usually a deposit into a bank account) or, if the corporation has a  dividend reinvestment plan, the amount can be paid by the issue of further shares or  share repurchase.

Dividends are generally described in terms of dividend payout ratio, which indicates the

amount                of   dividends   paid   relative   to   the   comp

Dividend Payout Ratio = Dividend per Share

Earnings per Share

Question: 1/:- Who decides dividend? Or who take decision about paying dividend?

Firms’boardof directors takes decisions for the payment of dividend in annual or quarterly meetings.

Question: 2/:- what are the key inputs to dividend decision?

The past period performance and future outlook, as well as recent dividend paid, are key inputs to the dividend decision.

Question: 3/:- Who set amount of dividend? & How?

Who? – Firm’s board of directors set the amount oattorneys, accountants and other professional.

How? – Primarily it depends on the firm’s dividenrespect to the periodic dividend, but the fir basis of significant increases in earnings.

Question: 4/:- who sets dates for dividends?

If the directors of the firm declare a dividend, they also typically issue a statement indicating the dividend decision, the record date and the payment date. This statement is generally quoted in the Wall Street Journal, Business Recorder and other financial news media.

1


Institutional Features of

Dividends

1.  Dates

Declaration date: – announcement by Board of directors that they will pay dividend on specific date.

Last with dividend date (Cum Dividend date):- Period during which the share purchaser is qualified to receive a previously announced dividend.

Ex-dividend date (Reinvestment date):- Shares purchased on or after the ex-dividend date does not include a right to the forthcoming dividend payment.

Record date (Closing Books):- All persons whose names are recorded as stockholders

on the date of record set by directors receive a declared dividend at a specified future time. These stockholders are often referred to as holders of record.

This is 4 days after the ex-dividend date.

The idea is that if shares are traded cum-dividend, brokers have time to notify the share register to ensure the new shareholder receives the dividend.

Payment date: – the payment date is also set by the directors, is the actual date on which the firm mails the dividend payment to the holders of record. It is generally a few weeks after the record date.

1.  Dividend Declaration Procedures (Time Frame):-

·A final dividend is paid after the end of the accounting or reporting year. ·An interim dividend can be paid any time before the final report is

released, usually after the half-yearly accounts are released.

The board of directors determines the timing for payment of dividends. For example, if a corporation enjoys a profitable quarter, the board of directors can elect to pay dividends to shareholders at the conclusion of that time period. In the alternative, the board of directors can determine to pay dividends after a profitable year.

A dividend may be annually, semiannually (interim), biannual (every two years) or quarterly. UK quoted companies usually payout dividends every 6 months (an interim and a final payment).US counterparts such as IBM will often pay quarterly dividends.

Note: – Quarter   base   is       prevailing   in

2.  Legal Considerations

– Dividends can only be paid out of profit and are not to be paid out of capital.

– A dividend cannot be paid if it would make the company insolvent.

– Dividend restrictions may exist in covenants in trust deeds and loan agreements.

– Franked dividend carries credits for tax paid by the company.

Pakistan

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[Prepared by ~~~ Hina Saleem Butt~~~ | ms150400050]

– Under imputation, if a company has the capacity to pay a franked dividend then, as a general rule, it must do so.

  • Dividend Imputation a. Franked dividend
    ·Carries a credit for income tax paid by the company.  
b. Franking credit          
    ·Credit for company tax paid which, when distributed to shareholders, can  
    be offset against their tax liability.        
c. Withholding tax          
    ·Tax deducted by a company from the dividend payable to a non-resident  
    shareholder.          
d. franking account          
    ·Account that records tax paid on company profits, this identifies the total  
    amount of franking credits that can be distributed to shareholders in the  
    form of franked dividends          
Difference between Cum (Last with Dividend) & Ex-Dividend  
                 
  Cum-dividend         Ex-dividend    
1.  Cum-dividend (CD) comes before Ex-dividend   1. Not including the next dividend.  
(XD).       2. When share traded without dividend.  
2.  When a share is said to be ‘cum dividend’, it   3. When a company announce the dividend,  
means that it is offered for sale with an     after announcement and before distribution if  
entitlement to the next dividend payment     a seller sell the security  
attached. This dividend will already have been   4. When seller sell the security, the dividend  
declared (but not paid) by the company, so the     will remain with the seller, nothing transfers  
market knows how much it is worth and the     to buyer. So buyer will not receive any  
share price will reflect this. At some point     dividend.  
shortly before payment of the dividend is   5. Whenever a seller sells the ex-dividend  
actually due, the share will go ‘ex dividend’,     security, the price of security reduces.  
3.  Payment of cum-dividend is due in near future.            
4.  Investor who buys the share now will receive            
the dividend.                
When people learn that they need to own the stock only for a short period of time they start  
deluding themselves that they could just capture the dividend and have small capital gains. The  
main issue is that traders with a short-term mindset who are trying to take advantage of the  
dividend capture strategy could be exposing themselves to severe market volatility. This strategy  
could be profitable during bull markets as stock prices in general increase which would help the  
speculators in unloading their position at a profit; during bear markets when the volatility is very  
high, the risk of catching a big wave down is much higher. 3


Question: 5/:- Why stocks price decline in the case of Ex- Dividend?

(VU         Instructor’s   reply)

Stock price will temporarily fall for ex-dividend stock but it will immediately regain its price due to market phenomenon. As the amount of dividend will be excluded from ex-dividend stocks so, its price will exactly fall with the amount of dividend.

For example, if a stock price is Rs. 50 and dividend of Rs. 1 has been announced the ex-dividend stock price will be Rs. 49 means ex-dividend stock will be sold on Rs. 49 to compensate the new

buyer for not receiving the dividend. However, these are all practic in which all the information is available to all investors.

Question: 6/:- What if I bought the stock on exactly ex-dividend date and then sell it the next day? Do I get the dividends or not?

Instructor’s                                 Reply:

Dear Student,

If you buy any stock before ex-dividend date only then you will be entitled to receive the dividend. Ex-dividend date means any trading of stock on this date will be done after excluding dividend. In simple words, if stocks (on which dividends have been announced) are bought or sold on ex-dividend date, the previous owners will be entitled to receive the dividend for that particular period.

For example, If Mr. Ali buys a stock on which dividend has been announced before ex-dividend date, he will receive the dividend date but if he buys such stock on or after ex-dividend date, he will not receive the dividend.

Question: 7/:- If I bought the dividend stock before the ex-dividend date and sell it on the ex-dividend date or after, do i still entitled for the dividend payout? or do I need to wait till the payout date?

Instructor’s                                 Reply:

Dear Student,

If an investor say Mr. Ali buys any stock before ex-dividend date and keeps in his possession till ex-dividend date, he will be entitled to receive the dividend. Even if Mr. Ali sells this stock on or after ex-dividend date to another party, he will receive dividend for that particular period.

However, only in the case, if Mr. Ali sells stock before ex-dividend date, he will not be entitled to receive the dividend for that stock.

Financial Factors Affecting

the Dividend Policy

1.   DPS to Face Value: This ratio evaluates the relationship between dividend per share andface value of the share. It is calculated as:

ü Dividend Yield ratio= Dividend per share/Face value per share 4 2. DPS to Market Value (Yield ratio): This ratio evaluates the relationship between

dividend per share and market value of the share. It is calculated as:


  • ü  Dividend Yield ratio= Dividend per share/Market value per share
  1. Dividend Payout Ratio: It indicates the extent to which the earnings per share have beenretained by a company. It enables the company to plough back the profits which will result in more profits in future and hence, more dividends. It is calculated as:
    1. Dividend Pay-Out Ratio= Dividend per equity share/Earnings per share

The higher the ratio, lower is the dividend payment and vice-versa.

  1. Current Ratio: It is a measure oflly usedfirformeasuring’sliquidittheshort-term financial position or liquidity of the firm. It indicates the ability of the firm to meet its current liabilities. It is calculated as:

ü Current Ratio= Current assets/Current liabilities

A high ratio indicates that firm’s liquidity position is good and obligations while a low ratio implies that fi all its obligations. However, a ratio of 2:1 is considered satisfactory. The expected relation

between current ratio and dividend payment is positive.

5.   Net Profit Ratio: This ratio establishes the relation between net profits and sales andindicates the management’s efficiency. It

ü Net Profit ratio= (Net Profit/Net sales)*100

As dividends are declared from the net profits of a firm, so higher the net profit ratio, higher will be the expected dividend payment.

6.  Net Profit to Net worth: This ratio indicates the relation between net profits earned by a

company and the net worth which is represented by shareholde of equity share capital, preference share capital, free reserves and surpluses, if any. It is

also referred to as return on investment and is calculated as:

ü Return on shareholder’sfit/NetWorth investment= Net This ratio is an indication of company’s abil company is more, more dividend payment can be expected and vice-versa.

  1. Debt Equity Ratio: This ratio measures the claims of outsiders and owners against the

firm’s assets. It indicates the relation b is calculated as:

ü Debt-equity ratio= Outsiders funds/Shareholders funds

This ratio tells the solvency position of the firm. Higher the ratio, better will be the solvency as well as the ability of firm to pay dividends. The vice-versa will hold true in case of low ratio.

8.   Lagged Profits: The dividend is not only influenceby the past year’s companyprofitscanfollow.theThisstabledividendis so bec policy if it has sufficient current year’s

  1. Behavior of Share Prices: The prevailing share prices also influence the dividendpayment by a company. If the share prices of a company are unfavorable, then it may

increase the dividend in order to boost up the share prices. It can be calculated as: ü Behavior of share prices= Higher share price – Lower share price

Higher share price + Lower share price

10. Growth in Earnings: If the earnings of a company increase, then the chances of increase

in dividend payment are also there. Growth is must for the survival of a company. This 5 ratio can be calculated as:

ü Growth in Earnings= EPSt- EPSt-1 / EPSt-1


Where, EPSt= Current earnings per share

EPSt-1= Previous earnings per share

  1. Growth in Working Capital: This ratio indicates increase in the working capital of acompany

ü Growth in Working Capital= WCt- WCt-1 / WCt-1 Where, WCt= Current working capital

WCt-1= Previous working capital

Higher ratio indicates the increase in the capacity of a company to pay dividends but this is interrelated with other factors also. Like, if a company has increase the working capital to match the increased level of operations, then this ratio will not be useful in studying the impact on the dividend payments.

12. Lagged Dividends: A company may consider the past ya company prefers stability of dividend pa dividend rate and can act accordingly.

  1. Tobin’s:ThisvariableQ represents the investment opportunities for a company. It ismeasured as
  • (MV of equityBV of equity +Total Assets)/Total Assets
  1. Investment Opportunity Set (Market to Book Value): It represents the availability ofinvestment opportunities to the company and generally is believed to have negative relationship with dividend payout.
  1. Free Cash Flow:This variable is used to measure the availability of cash with thecompany. It is calculated as
  • (Cash flow from Operations-Cash flow from investment activities)/Total assets
  1. Cash Holdings: It is another financial variable to analyze the liquidity position of thefirm. It is calculated as
  • (Cash + Short-term investment)/Total assets
  1. Uncertainty in Earnings: It refers to the variation in the earnings from one year toanother. Some companies might witness irregular earnings and thus, may not have stable dividend policy. Uncertainty in earnings can be measured as
    1. σ   = x2√./ N)(∑

A small value of standard deviation means high degree of uniformity in the earnings and vice-versa.

  1. Solvency Ratio: This ratio is a small variant of equity ratio. It indicates the relationshipbetween total liabilities to outsiders to total assets of a firm. It can be calculated as:
    1. Solvency ratio= Total Liabilities to Outsiders/Total Assets
  1. Return on Net worth: This ratio is also termed as return on investment. This ratioindicates the relationship between net profits (after interest and tax) and the shareholders funds. It can be calculated as
  • Net profit (after interest and taxes)/Shareholders funds
  1. Return on Capital Employed: This ratio establishes the relationship between profits andcapital employed. It can be calculated as
ü 6

(Adjusted Net Profits/Gross Capital Employed)*100 Or

ü (Adjusted Net Profits/Net Capital employed)*100


Advantages of Paying

Dividend

Paying dividends to investors has several advantages, both to the investors and the company:-  Investor Preference for Dividends: The investors are more interested in a company thatpays stable dividends. This assures them of a reliable source of earnings, even if the market price of the share dips.

Bird-in-hand Fallacy: This theory states that the shareholders prefer the certainty ofdividends in comparison to the possibility of higher capital gains in future.

Stability: Investors prefer companies that have a track record of paying dividends as itreflects positively on its stability. This indicates predictable earnings to investors and thus, makes the company a good investment.

Benefits without Selling: Investors invested in dividend-paying stocks do not have tosell their shares to participate in the growth of the stock. They reap the monetary benefits without selling the stock.

Temporary Excess Cash: A mature company may not have attractive venues to reinvestthe cash or may have fewer expenses related to R&D and expansion. In such a scenario, investors prefer that a company distributes the excess cash so that they can reinvest the money for higher returns.

Information Signaling: When a company announces the dividend payments, it gives astrong signal about the future prospects of the company. Companies can also take advantage of the additional publicity they get during this time.

Disadvantages of

Paying Dividend

Paying dividends also has several disadvantages:-

Clientele Effect: If a dividend-paying company is unable to pay dividends for a certainperiod of time, it may result in loss of old clientele who preferred regular dividends. These investors may sell-off the stock in short term.Decreased Retained Earnings: When a company pays dividends, it decreases itsretained earnings. Debt obligations and unexpected expenses can rise if the company does not have enough cash.

Limits                 Company’sPayingdividendsGrowth:resultsinreduction of usable cash which

may limit the company’s growth. The compan business growth.

Logistics: The payment of dividends requires lot of record-keeping   at   the   com

end. The company has to ensure that the right owner of the share receives the dividend. 7


Types of Dividends

¤ On the basis of Types of Share ü Equity Dividend

ü Preference Dividend

¤ On the basis of Mode of Payment ü Cash Dividend

ü Stock Dividend

ü Bond Dividend ü Property Dividend

ü Composite Dividend

¤ On the basis of Time of Payment ü Interim Dividend

ü Regular Dividend

ü Special Dividend

Note: – In our course FIN722 we focus only on two types of dividends i.e. Cash & StockDividends.

Cash Dividends:-

ü The Cash dividend is by far the most common of the dividend types used. ü On the date of declaration, the board of directors resolves to pay a certain

dividend amount in cash.

ü It is paid to those investors holding the company’s stock on a specific date. ü The date of record is the date on which dividends are assigned to the

holders of the company’s stock.

ü On the date of payment, the company issues dividend payments.

Stock Dividends:-

ü A Stock dividend is the issuance by a company of its common stock. ü It is issued to its common shareholders without any consideration.

ü If the company issues less than 25 percent of the total number of previously outstanding shares, you treat the transaction as a stock dividend.

ü If the transaction is for a greater proportion of the previously outstanding shares, then treat the transaction as a “stock split”

ü To record a stock dividend, transfer from retained earnings to the capital stock

ü And additional paid-in capital accounts an amount equal to the fair value of the additional shares issued.

ü The fair value of the additional shares issued is based on their fair market value when the 8  
   
dividend is declared.    


Dividend Policy

Dividend policy is the set of guidelines (how much to pay) a company uses to decide how muchof its earnings it will pay out to shareholders. Some evidence suggests that investors are not concerned with a company’s dividend policy since they can sell a portion of their portfolio of equities if they want cash.

¤ Theories of Dividend Policy

Relevant Theory

Relevant Theory – consider dividend decision to be relevant as it affects the value of the firm

  • Walter’s-Prof.ModelJamesEWalter argued that in the long-run the share prices reflect only the present value of expected dividends. Retentions influence stock price only through their effect on future dividends. Walter has formulated this and used the dividend to optimize the wealth of the equity shareholders.
  • Assumptions   of-  Walter’s   Model:
  • Internal Financing
  • constant Return in Cost of Capital
  • 100% payout or Retention
  • Constant EPS (Earning per share) and DPS (Dividend per share)
  • Infinite time
  • Formula   of   Walter’s:-   Model
  • P = [{D + r (E –D)}/K]/K

Where,

P = Current Market Price of equity share E = Earning per share

D         = Dividend per share

(E-D)  = Retained earnings per share

r = Rate of Return on firm’s investmen k = Cost of Equity Capital

Examples for Walter’dels   Mo

  Growth Firm (r > k):     Normal Firm (r = k):     Declining Firm (r < k):  
r = 20%, k = 15%, E = Rs. 4 r = 15%, k = 15%, E = Rs. 4 r = 10%, k = 15%, E = Rs. 4
If  D = Rs. 4     If D = Rs. 4     If D = Rs. 4    
P = 4+(0) 0.20 /0 .15 = Rs. 26.67 P = 4+(0) 0.15 / 0.15 = Rs. 26.67 P = 4+(0) 0.10 / 0.15 = Rs. 26.67
0.15     0.15     0.15    
If  D = Rs. 2     If D = Rs. 2     If D = Rs. 2    
P = 2+(2) 0.20 / 0.15 = Rs. 31.11 P = 2+(2) 0.15 / 0.15 = Rs. 26.67 P = 2+(2) 0.10 / 0.15 = Rs. 22.229
0.15     0.15     0.15    
                       

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Effect of Dividend Policy on Value of Share

  Case     If Dividend Payout ratio Increases     If Dividend Payout Ration  
                decreases    
In case of Growing firm i.e. where r > k Market Value of Share decreases Market Value of a share increases
     
In case of Declining firm i.e. where r < k Market Value of Share increases Market Value of share decreases
In case of normal firm i.e. where r = k No change in value of Share No change in value of Share
                     

Criticism

of

Walter’s

Model

– No External Financing

– Firm’s   internal   rate   of   return   does   not   al

more investment in made.

cost of capital does not always rem the firm’s risk.

  • Gordon’s-AccordingModeltoProf. Gordon, Dividend Policy almostalways affects the value of the firm. He showed how dividend policy can be used to maximize the wealth of the shareholders.
  • The main proposition of the model is that the value of a share reflects the value of the future dividends accruing to that share. Hence, the dividend payment and its growth are relevant in valuation of shares.
  • The model holds that the share’s market discounted future dividend payment.

v Assumptions of Gordon’s   Model:-

  • All equity firm
  • No external Financing
  • Constant Returns
  • Constant Cost of Capital
  • Perpetual Earnings
  • No taxes
  • Constant Retention
  • Cost of Capital is greater then growth rate (k>br=g)

v Formula   of   Gordon’s-   Model:

P = {E (1 –b)} / (k –br)

Where,

P = Price

E = Earnings per Share

b = Retention Ratio

k = Cost of Capital

br = g = Growth Rate

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Examples:-

    Growth Firm (r > k):           Normal Firm (r = k):       Declining Firm (r < k):      
  r = 20%, k = 15%,  E = Rs. 4   r = 15%, k = 15%,  E = Rs. 4   r = 10%, k = 15%,  E = Rs. 4    
  If b = 0.25       If b = 0.25         If b = 0.25        
  P0 = (0.75) 4 =Rs. 30   P0 = (0.75) 4 = Rs. 26.67   P0 =   (0.75) 4 =Rs. 24    
                                 
0.15- (0.25)(0.20)         0.15- (0.25)(0.15)        
            0.15- (0.25)(0.10)        
                                   
  If b = 0.50       If b = 0.50         If b = 0.50        
  P0 = (0.50) 4 = Rs. 40   P0 = (0.50) 4 = Rs. 26.67          
      P0 =   (0.50) 4 = Rs. 20    
                                 
    0.15- (0.5)(0.20)         0.15- (0.5)(0.15)            
                        0.15- (0.5)(0.10)        
                                         
                                         
                                         
Criticism                                      
  of       assumptionsand ofGordon’sWalter’sModelModelare   sam  
Gordo    
from the same limitations as the   Walter’s   Model.  
  Model  
                                       

Irrelevant Theory

Irrelevant Theory – consider dividend decision to be irrelevant as it does not affect the value of the firm

Modigliani & Miller’sodel–itisusedIrrelevanceinfinanceandeconomicsto determineM the value of the firm.

  • Value of the firm (i.e. wealth of shareholders) depends on Firms Earning
  • And Firms Earnings depends on Firm’s   Investment   policy   and
  • Assumption
  • Capital Markets are Perfect and people are Rational
  • No taxes
  • Floating Costs are nil
  • Investment opportunities and future profits of firms are known with certainty (This assumption was dropped later)
  • Investment and Dividend Decisions are independent
  • M-M’s   Argument
  • If a company retains earnings instead of giving it out as dividends, the shareholder enjoys capital appreciation equal to the amount of earnings retained.
  • If it distributes earnings by the way of dividends instead of retaining it, shareholder enjoys dividends equal in value to the amount by which his capital
  would have appreciated had the company chosen to retain its earning.   11  
ü Hence, the division of earnings between dividends and retained earnings is  
   
  IRRELEVANT from the point of view of shareholders.    


  • Formula of M-M’s   Approach

P0 = D1/ (1+r) 1 + D2/ (1+r) 2

Ø Consider a firm that can either pay out dividends of $10,000 per year for each of the next two years or can pay $9000 this year, reinvest the other $1000 into the firm and then pay $11,120 next year. Investors require a 12% return.

Solution/:-

Assuming that the second dividend is a liquidating dividend and the firm ceases to exist after

period 2.

Market Value with constant dividend = PV = 10,000 / 1.12 + 10,000 / 1.122 = 16,900.51 Market Value with reinvestment = PV = 9000 / 1.12 + 11,120 / 1.122 = 16,900.51

If   the   company   will   earn   the   required   return,

  • Criticism of M-M Model
  • No perfect Capital Market
  • Existence of Transaction Cost
  • Existence of Floatation Cost
  • Lack of Relevant Information
  • Differential rates of Taxes
  • No fixed investment Policy
  • Investor’s   desire   to   obtain   current   inc

Residual

Dividend Policy

– Accept all investments with positive net present values

– Determine capital budget

– Determine target capital structure

– Find the retained earnings needed for the capital budget.

– Pay out any leftover earnings (the residual) as dividends.

– This policy minimizes flotation and equity signaling costs, hence minimizes the WACC.

– Finance investments with a combination of debt and equity in line with the target capital structure

Remember that retained earnings are equity

If additional equity is needed, issue new shares

– If there are excess earnings, then pay the remainder out in dividends

– If there are no residual funds, pay no dividend

Example: – Given

Need $5 million for new investments, Target capital structure: D/E = 2/3 Net Income = $4 million

ü Finding dividend 12  
40% financed with debt (2 million)  
   
60% financed with equity (3 million)    
  • •         NI –equity financing = $1 million, paid out as dividends
  • If D/E = 2/3, the V = 2 + 3 = 5, so D/V = 2/5 = 40% and E/V = 3/5 = 60%
éæTarget  ö æTotal öù  
ç ÷ ç ÷  
ê ´ capital ú  
Dividends  =Net Income –   equity ÷  
ç ÷ ç  
ê   ú  
ç ÷ ç ÷  
ê ratio budget ú  
ëè ø è øû  

Capital budget –$800,000, Target capital structure= 40% debt, 60% equity, Forecasted net income= $600,000

  • How much of the forecasted net income should be paid out as dividends?
  • Calculate portion of capital budget to be funded by equity.

Of the $800,000 capital budget, 0.6($800,000) = $480,000 will be funded with equity.

¤ Calculate excess or need for equity capital.

With net income of $600,000, there is more than enough equity to fund the capital budget. There will be $600,000 – $480,000 = $120,000 left over to pay as dividends.

¤ Calculate dividend payout ratio

$120,000 / $600,000 = 0.20 = 20%

¤ If   NI   =   $400,000   …

Dividends = $400,000 –(0.6)($800,000) = -$80,000.

Since the dividend results in a negative number, the firm must use all of its net income to fund its budget, and probably should issue equity to maintain its target capital structure.

Payout = $0 / $400,000 = 0%

¤ If   NI   =   $800,000   …

Dividends = $800,000 –(0.6)($800,000) = $320,000. Payout = $320,000 / $800,000 = 40%

  • How would a change in investment opportunities affect dividend under the residual policy?

– Fewer good investments would lead to smaller capital budget, hence to a higher dividend payout.

– More good investments would lead to a lower dividend payout.

Advantage –Minimizes new stock issues and flotationcosts.

Disadvantages –Results in variable dividends, sendsconflicting signals, any specific clientele.

Comments on Residual Dividend Policy

an

Conclusion –Consider residualfollow it rigidly.

policy                  when   sett

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 Stable Dividend

Policy

Stable Dividend Policy: (dividend does not change)

Under the stable dividend policy, the company aims for a steady dividend payout every year. It does not change even if the earnings are volatile every year. The approximate level for the

dividend                     payout   is   determined   by-termlookingearnings.   at   a

This approach aligns the dividend growth rate of the company with its long-run earnings growth rate.

The stable dividend policy is the most popular dividend policy. Under this approach, short-term earnings’ volatility is not reflected in the about the future dividends’hasthefollowingvery reallevelpossibilities:. This polic

Dividends may rise even in periods when earnings of the company decline.

Dividends may not increase at the same higher rate of earnings in the booming years.

Because of these, the stable dividend policy may gradually move towards a target payout ratio.

A target payout ratio is defined as a strategic goal which represents the share of earnings thatthe company aims to distribute as dividends to shareholders over a long-term. One such model on these lines of gradual adjustment is the target payout ratio adjustment model. Under this model, if the earnings of the company are expected to rise and the current dividend payout ratio is below the target dividend payout ratio, the investor can calculate the estimated future dividends as follows:

Expected Dividend = (Previous Dividend) + [(Expected Increase in EPS) * (Target Payout Ratio) * (Adjustment Factor)]

Where adjustment factor = 1/ number of years over which the dividends adjustments will happen.

Advantages:-

– Paying a constant or constantly growing dividend each year:

– offers investors a predictable cash flow

– reduces management opportunities to divert funds to non-profitable activities

– Works well for mature firms with stable cash flows.

Disadvantages:-

– There is a risk that reduced earnings would force a dividend cut with all the associated difficulties.

Constant

Dividend Policy

Constant Dividend Policy: (same percentage of equity earning every year)

Under              the   constant   dividend   policy,   a   specifias

dividends every year.   The   short   term   earnings’   volatility

14 hence, the amount of dividends varies directl

policy is not used very frequently in companies

[Prepared by ~~~ Hina Saleem Butt~~~ | ms150400050]

This policy does not imply that the dividend per share will never be increased.

When the company reaches new levels of earnings and expects to maintain it, the annual dividend per share may be increased.

The dividend policy of paying a constant amount of dividend per year treats common shareholders somewhat like preference shareholders without giving any consideration to investment opportunities within the firm and the opportunities available to shareholders.

This policy is generally preferred by those persons and institutions that depend upon the dividend income to meet their living and operating expenses, increases and decreases in market values may even be of little concern to these investors, and this condition tends to produce a steady long-run demand that automatically stabilizes the market value of the share.

Advantages:-

– Maintains a link between earnings, reinvestment rate and dividend flow but

Disadvantages:-

– Cash flow is unpredictable for the investor

– Gives no indication of management intention or expectation.

Question/:- Stable policy dividend practice questions are not available in books and internet; same minor example just says 2 or 3. So how could I practice more?

There are no spate separate practice questions for this policy. You may find somewhere in questions related to dividend discount models. In dividend discount related questions, it may be asked that which type of dividend policy a company is following by providing the relevant information. For example, a scenario can be given like this: “A company has announced Rs. 3 per share dividend so, identify whether this refers to constant dividend policy or stable dividend policy?” (VU Instructor’s reply)

Question/:- No formula for stable dividend policy?

These are the policies decided by company’ management and are based upon company’ financial situation. This is totally on company’s management decision whether they are going to announce a fixed amount of dividend or a fixed %age of earnings. If a fixed amount is decided then the amount will be announced like Rs. 2 or Rs. 3 per share etc. In such case, no need of formula as exact dividend amount is declared. However, if fixed %age is announced then shareholders identify the exact amount of dividend by multiplying the announced %age with available earnings.  (VU Instructor’s reply)

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References/:-

  1. www2.fiu.edu/~keysj/TKM_CH_16.ppt
  2. http://dictionary.reference.com/browse/dividend
  3. https://www.google.com.pk/#q=what+is+dividend
  4. https://en.wikipedia.org/wiki/Dividend
  5. [PPT]  Chapter 15-Dividend Policy and Internal Financing
  6. http://smallbusiness.chron.com/decides-pay-dividends-corporation-3973.html
  7. [PPT]Dividend  Policy – McGraw-Hill Education
  8. http://moneyterms.co.uk/cum-dividendex-dividend/
  9.  http://shodhganga.inflibnet.ac.in/bitstream/10603/8955/11/11_chapter%205.pdf
  1. http://www.bigfatpurse.com/2008/04/what-is-the-difference-between-cum-dividend-and-ex-dividend/
  1. http://www.finance-glossary.com/define/cum-dividend/337
  1. http://financial-dictionary.thefreedictionary.com/Ex-dividend
  2. https://www.google.com.pk/#q=ex-dividend+
  1. http://www.efinancemanagement.com/dividend-decisions/dividends-forms-advantages-and-disadvantages
  1.  http://www.slideshare.net/PoojaNarwani/dividend-policy-9334231
  2.  http://www.slideshare.net/gayu_vijay/dividend-types
  1.  http://www.yourarticlelibrary.com/financial-management/dividend-policies-advantages and-disadvantages-of-stability-of-dividends/29424/
  1. http://kfknowledgebank.kaplan.co.uk/KFKB/Wiki%20Pages/The%20Dividend%20Decis

ion.aspx?mode=none

  1.  http://www.efinancemanagement.com/dividend-decisions/dividend-payout-policies
  2. wps.pearsoned.co.uk/wps/media/objects/1670/…/0273685988_ch18.ppt
  3.  Dividend Policy – NYU Stern School of Business
  1. 140.133.72.206:8080/7309/財管7.0教學投影片/Chapter_18.ppt
  1. https://www.google.com.pk/url?sa=t&rct=j&q=&esrc=s&source=web&cd=7&cad=rja&u  act=8&sqi=2&ved=0ahUKEwi6xvS5gJ7KAhUEco4KHaBfBXIQFgg-MAY&url=http%3A%2F%2Fwww.csulb.edu%2F~svle%2FChapter15.ppt&usg=AFQjC  NFNHAoRO1hBC9icCmBOF2QmDiw_PQ&bvm=bv.111396085,d.c2E
  1.  http://www.investopedia.com/walkthrough/corporate-finance/5/dividends/policy.aspx
  1.  www.slideshare.net/PoojaNarwani/dividend-policy-9334231
  1. http://www.slideshare.net/rohanjagtap007/types-of-dividend-policy

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