Beruflich Dokumente
Kultur Dokumente
Sections
Section • the effects of differences in dividend policy on the current price of shares in an ideal
I economy characterized by perfect capital markets, rational behavior, and perfect
certainty.
Section
• what investors "really" capitalize when they buy shares;
II
Section • relations between price, the rate of growth of profits, and the rate of growth of
III dividends per share
Section • drops the assumption of certainty to see the extent to which the earlier
IV conclusions about dividend policy must be modified.
Section • the implications for the dividend policy problem of certain kinds of market
V imperfections.
Perfect Capital Market
• Conditions that face a firm operating in a
perfect capital market, either;
1. The firm has sufficient funds to pay dividend
2. The firm does not have sufficient funds to
pay dividend therefore it issues stocks in
order to finance payment of dividends
3. The firm does not pay dividends but the
shareholders need cash
Assumptions
Perfect capital markets:
• No income taxes.
• No flotation or transaction costs.
• Leverage does not affect cost of capital
• Both managers and investors have access to the same information
concerning firm's future prospects.
• Firm's cost of equity is not affected by distribution of income between dividend
and retained earnings.
• Dividend policy has no impact on firm's capital budgeting
Rational behavior:
• Investors prefer more wealth to less.
• Investors indifferent between cash payment or increment in market value
of shares.
Perfect certainty:
• Future dividends and CFs are known.
Section I: Effects of dividend policy
• dj(t) = dividends per share paid by firm
• pj(t) = share price (ex any dividend in t -1)
pj(t) 1 (t)
1 [dj( pj(t 1
t) )]
(2) equiv
alent
Cont.
• Fundamental principle:
– The share price must make shares in every market
have same rate of return (dividend plus capital
gain)
– This process tend to drive down the prices of the
low-return shares and drive up the prices of high-
return shares until any difference in rates of return
had been eliminated by arbitraging or switching.
The effect of dividend policy
• n(t) = the number of shares of record at the
start of t
• m(t + 1) = the number of new shares (if any)
sold during t at the ex dividend closing
price p(t + I), so that
• n(t + 1) = n(t) +m(t + 1)
• V(t) = n(t) p(t) = total value of the enterprise
• D(t) = n(t) d(t) = total dividends paid during t
to holders of record at the start of t
Cont.
• we can rewrite (2)
• T 1
V (t) [D(t) V (t 1) m(t 1) p(t (3)
o 1 1)]
(t)
• Dividend policy problem; dividend decision effects price in
two conflicting ways:
– directly via D(t) and
– inversely via -m(t) p(t +1)
• Dilemma:
– To reduce dividend and rely on retained earnings, or
– To raise dividends but float more new shares?
• For the higher the dividend payout in any period, the more
new capital must be raised from external sources to
maintain any desired level of investment.
• The two effects must always cancel out so that the dividend
policy will have no effect on the price.
Cont.
– I(t) = level of the firm's investment
– X(t) = firm's total net profit for the period
• The amount of outside capital required:
m(t 1) 1) I (t) [ X (t) D(t)] (4)
p(t
Substituting expression (4) into (3)