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DIVIDEND THEORY

Highlight the issues of dividend policy Critically evaluate why some experts feel that dividend

policy matters Discuss the bird-in-the-hand argument for paying current dividends Explain the logic of the dividend irrelevance Identify the market imperfections that make dividend policy relevant Understand information content of dividend policy

Dividend

policy involves the balancing of the shareholders desire for current dividends and the firms needs for funds for growth.

Earnings to be Distributed High Vs. Low Payout.


Objective Maximize Shareholders Return. Effects Taxes, Investment and Financing

Decision.

Walter's Model

Gordon's Model
Modigliani and Miller Hypothesis The Bird in the Hand Argument

Informational Content
Market Imperfections

Walters model is based on the following assumptions: Internal financing Constant return and cost of capital 100 per cent payout or retention Constant EPS and DIV Infinite time

Growth Firms Retain all earnings

Normal Firms Distribute all earnings


Declining Firms No effect

No external financing

Constant return, r
Constant opportunity cost of capital, k

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Gordons model is based on the following assumptions:


All-equity firm
No external financing Constant return Constant cost of capital

Perpetual earnings
No taxes Constant retention Cost of capital greater than growth rate

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Market value of a share is equal to the present value of an

infinite stream of dividends to be received by shareholders.

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Argument put forward, first of all, by Kirshman Investors are risk averters. They consider distant

dividends as less certain than near dividends. Rate at which an investor discounts his dividend stream from a given firm increases with the futurity of dividend stream and hence lowering share prices.

According to M-M, under a perfect market situation, the

dividend policy of a firm is irrelevant as it does not affect the value of the firm. They argue that the value of the firm depends on firm earnings which results from its investment policy. Thus when investment decision of the firm is given, dividend decision is of no significance.
It is based on the following assumptions: Perfect capital markets No taxes Investment policy No risk

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Tax Differential Low Payout Clientele Flotation Cost Transaction and Agency Cost Information Asymmetry Diversification Uncertainty High Payout Clientele Desire for Steady Income No or Low Tax on Dividends

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. In an uncertain world in which verbal statements

can be ignored or misinterpreted, dividend action does provide a clear cut means of making a statement that speaks louder than a thousand words. Solomon