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  • Dividend Theories 11

    Transféré par

    Lalit Shah
    40 vues16 pages
    Dividend theories can be categorized as either relevance theories or irrelevance theories. The two main relevance theories are Walter's Model and Gordon's Model. Walter's Model is based on the internal rate of return (r) and cost of capital (Ko) to determine the optimal dividend payout ratio for growth, normal, and declining firms. Gordon's Model asserts that share price depends on the dividend payout ratio and uses the variables of earnings, retention ratio, dividend payout ratio, discount rate, and growth rate in its formula. The Miller and Modigliani Hypothesis falls under the irrelevance theories, stating that the value of a firm is determined by its earnings power and risk regardless of its dividend policy

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    Dividend theories can be categorized as either relevance theories or irrelevance theories. The two main relevance theories are Walter's Model and Gordon's Model. Walter's Model is based on the internal rate of return (r) and cost of capital (Ko) to determine the optimal dividend payout ratio for growth, normal, and declining firms. Gordon's Model asserts that share price depends on the dividend payout ratio and uses the variables of earnings, retention ratio, dividend payout ratio, discount rate, and growth rate in its formula. The Miller and Modigliani Hypothesis falls under the irrelevance theories, stating that the value of a firm is determined by its earnings power and risk regardless of its dividend policy

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    40 vues16 pages

    Dividend Theories 11

    Transféré par

    Lalit Shah
    Dividend theories can be categorized as either relevance theories or irrelevance theories. The two main relevance theories are Walter's Model and Gordon's Model. Walter's Model is based on the internal rate of return (r) and cost of capital (Ko) to determine the optimal dividend payout ratio for growth, normal, and declining firms. Gordon's Model asserts that share price depends on the dividend payout ratio and uses the variables of earnings, retention ratio, dividend payout ratio, discount rate, and growth rate in its formula. The Miller and Modigliani Hypothesis falls under the irrelevance theories, stating that the value of a firm is determined by its earnings power and risk regardless of its dividend policy

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    sur 16

    Dividend Theories

    Dividend Theories

    Relevance Theories

    Walters Model
    Gordons Model

    Irrelevance Theories

    Miller and Modigliani Hypothesis.

    Relevance Theory

    When dividend decision affects value of a


    firm, it is known as relevance theory.
    There are two prime theories under this
    approach:

    Walters Model
    Gordons Model

    Walters Model

    This model is proposed by James Walter.


    This model is based on:

    Return on investment or internal rate of return [r]


    and
    Cost of Capital or Required Rate of Return [Ko]

    Model divides firm into


    Growth firms:

    r>K o

    Normal firms:

    r=K o

    Declining firms:

    r<K o

    Assumptions
    Only internal source of funds used
    r and K o constant
    All earnings are paid as dividends or completely
    reinvested
    EPS; and DPS never change
    Perpetual life

    Formula

    Where: P
    D
    E
    (ED)
    r
    Ke

    = Market Price per Share


    = Dividends per share;
    = Earnings per share;
    = Retained earnings per share;
    = Rate of return on investment;
    = Cost of capital.

    Interpretation
    r>K o=

    Optimum DP Ratio is zero

    r=K o=

    No optimum DP Ratio

    r<K o=

    Optimum DP Ratio 100%

    Criticisms
    No external financing
    Constant rate of return as investment
    Constant cost of capital

    Gordons Model

    According to this model, firms share price


    is dependent on dividend pay out ratio.

    Assumptions
    All equity firm;
    Properties financed by retained earnings;
    r is constant;
    K o remains constant;
    K o>b. r;
    Perpetual stream of earnings;
    Perpetual life;
    Retention ratio constant;
    No corporate taxes

    Formula
    Where: P=
    E=
    b=
    (1- b)=
    K=
    r=
    b. r =

    E (1 b)
    P
    K b r

    Price per share


    Earnings per share
    Retention ratio
    Dividend Payout ratio
    Rate of Discount
    Rate of returns earned an investment made by the firm
    growth rate

    Interpretation

    r > Ko = Optimal DP Ratio is zero.


    r = Ko = No Optimal DP Ratio.
    r < Ko = Optimal DP Ratio is 100%.

    MM Hypothesis

    According to this theory, value of the firm is


    determined by its basic earning power and
    its business risk.

    Assumptions
    Existence of perfect capital markets
    No taxes
    Firm has fixed investment policy
    There is no risk

    Thank You

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