INTRODUCTION
A dividend decision policy of a firm is a crucial area of financial management. The importance of a dividend policy is to determine the amount of earnings or profit made by the company to be distributed to shareholders and the amount to be retained in the firm. The amount retained is called retained earnings this are the most significant internal sources of financing the growth of the firm. On the shareholder side dividends are considered desirable because they may increase the shareholders current return.
DIVIDEND THEORIES
Over the year’s different dividend policies have emerged, the four main dividend policy theories are:
(1) Gordon and Lintner’s bird-in-the hand theory (2) Miller and Modigliani’s dividend irrelevance theory …show more content…
• No form of external financing is available. In this case retained earnings would be used to finance any company activities like expansion. Thus, just as Walter’s model Gordon’s model does not consider dividend and investment policies as a source of raising funds in an organisation.
• The internal rate of return (r) or (IRR) of the firm is constant and does not change. This means that the diminishing marginal efficiency of investments is ignored.
• There is a constant cost of capital; the discount rate (k) for the firm remains constant. Thus, Gordon’s model also ignores the effect of a change in the firm’s risk-class and its effect on the discount rate (k). • The firm and its stream of earnings is constant and doesn’t change . • There is no corporate tax . • The retention ratio denoted by (b) once decided upon remains constant. Thus, the growth rate, g = br, is constant forever.
• The cost of capital is greater than the growth rate .Thus the discount rate is greater than growth rate, k > br = g. If this condition is not met, we cannot get a meaningful value for the …show more content…
Gordon’s model has implications ,this are ; A growth firm’s internal rate of return (r) is greater than cost of capital (k). This means that for an increase in shares marker price dividends should be reinvested rather than distributed. Hence, the optimum pay-out ratio for growing firms is zero.
The market value of shares is not affected when the firm’s internal rate of return (r) is equal to cost of the capital (k). This means that the organisations do not make any difference if the company reinvested the dividends or distributed to its shareholders. Hence, there is no optimum dividend pay-out ratio for normal firms.
Later , Gordon revised this theory and stated that the dividend policy of the firm impacts the market value even when internal rate of return and cost of capital are equal r=k. Investors always prefer a share where more current dividends are
A dividend decision policy of a firm is a crucial area of financial management. The importance of a dividend policy is to determine the amount of earnings or profit made by the company to be distributed to shareholders and the amount to be retained in the firm. The amount retained is called retained earnings this are the most significant internal sources of financing the growth of the firm. On the shareholder side dividends are considered desirable because they may increase the shareholders current return.
DIVIDEND THEORIES
Over the year’s different dividend policies have emerged, the four main dividend policy theories are:
(1) Gordon and Lintner’s bird-in-the hand theory (2) Miller and Modigliani’s dividend irrelevance theory …show more content…
• No form of external financing is available. In this case retained earnings would be used to finance any company activities like expansion. Thus, just as Walter’s model Gordon’s model does not consider dividend and investment policies as a source of raising funds in an organisation.
• The internal rate of return (r) or (IRR) of the firm is constant and does not change. This means that the diminishing marginal efficiency of investments is ignored.
• There is a constant cost of capital; the discount rate (k) for the firm remains constant. Thus, Gordon’s model also ignores the effect of a change in the firm’s risk-class and its effect on the discount rate (k). • The firm and its stream of earnings is constant and doesn’t change . • There is no corporate tax . • The retention ratio denoted by (b) once decided upon remains constant. Thus, the growth rate, g = br, is constant forever.
• The cost of capital is greater than the growth rate .Thus the discount rate is greater than growth rate, k > br = g. If this condition is not met, we cannot get a meaningful value for the …show more content…
Gordon’s model has implications ,this are ; A growth firm’s internal rate of return (r) is greater than cost of capital (k). This means that for an increase in shares marker price dividends should be reinvested rather than distributed. Hence, the optimum pay-out ratio for growing firms is zero.
The market value of shares is not affected when the firm’s internal rate of return (r) is equal to cost of the capital (k). This means that the organisations do not make any difference if the company reinvested the dividends or distributed to its shareholders. Hence, there is no optimum dividend pay-out ratio for normal firms.
Later , Gordon revised this theory and stated that the dividend policy of the firm impacts the market value even when internal rate of return and cost of capital are equal r=k. Investors always prefer a share where more current dividends are