“There are two main schools of thought in respect to Dividend Policy: the Relevance and the Irrelevance Theories” Explain briefly.
What is so important about the Dividend Policy? One of the four main things, any company can do with its profits is to increase equity either by paying the shareholders in the form of a dividend or postponing this payment in the form of a reserve. Furthermore, the amount to pay as dividends is one of the crucial financial decisions the company has to take. Apart from that, the right understanding of this policy is also significant for other sectors in the financial industry like Mergers and Takeovers, the Capital Structure, the Capital Asset Pricing Model since these all depend on how and why …show more content…
The above formula was deduced from the development of the discounted dividends approach to firm valuation which states that, the value of the firm is the summation of this year’s dividends and the net present value of all future dividends being the cash flow coming from the …show more content…
This is because if the investment goes wrong, the shareholder would lose his dividends. This is referred to as the investor’s opportunity cost of capital for that particular period. Thus, the argument is that the more the company retains its profits, the lower the distribution dividend policy and the more the shareholder has to be compensated for the additional risk due to these uncertainties about future cash flows. This was basically what Myron Gordon argued about in 1959. He stated that the investor’s required rate of return rt would rise due to a rise in the firm’s profits. Although, the forthcoming dividends would probably be higher due to an increase in investment, Gordon perceived that a rise in rt would occur due to the higher uncertainty regarding profits as a result of reinvesting those earnings instead of distributing all dividends.
A similar model to that of Gordon’s is Walter’s model where he argues that the selection of dividend policies nearly always influences the firm’s value. This model illustrates the significance of the relation between the firm’s internal rate of return and its cost of capital in establishing the dividend policy that will maximise shareholders’ wealth. According to Walter, the market price per share is given
What is so important about the Dividend Policy? One of the four main things, any company can do with its profits is to increase equity either by paying the shareholders in the form of a dividend or postponing this payment in the form of a reserve. Furthermore, the amount to pay as dividends is one of the crucial financial decisions the company has to take. Apart from that, the right understanding of this policy is also significant for other sectors in the financial industry like Mergers and Takeovers, the Capital Structure, the Capital Asset Pricing Model since these all depend on how and why …show more content…
The above formula was deduced from the development of the discounted dividends approach to firm valuation which states that, the value of the firm is the summation of this year’s dividends and the net present value of all future dividends being the cash flow coming from the …show more content…
This is because if the investment goes wrong, the shareholder would lose his dividends. This is referred to as the investor’s opportunity cost of capital for that particular period. Thus, the argument is that the more the company retains its profits, the lower the distribution dividend policy and the more the shareholder has to be compensated for the additional risk due to these uncertainties about future cash flows. This was basically what Myron Gordon argued about in 1959. He stated that the investor’s required rate of return rt would rise due to a rise in the firm’s profits. Although, the forthcoming dividends would probably be higher due to an increase in investment, Gordon perceived that a rise in rt would occur due to the higher uncertainty regarding profits as a result of reinvesting those earnings instead of distributing all dividends.
A similar model to that of Gordon’s is Walter’s model where he argues that the selection of dividend policies nearly always influences the firm’s value. This model illustrates the significance of the relation between the firm’s internal rate of return and its cost of capital in establishing the dividend policy that will maximise shareholders’ wealth. According to Walter, the market price per share is given