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Relevance n Irrelevance of Dividend Policy

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Dividend theory
The term dividend theory refers to the part of a company which is
distributed by the company among its shareholder after execution of
retained earning it is the reward of the shareholder for the investment
made by them in the shares for the company.in other word it is retained
that a share holder gets from the company out of profit on his
shareholding
A major decision of financial management is the dividend in the sense that
the firm has to choose between distributing the profits to the shareholder
and ploughing them back into the business, the choice would obviously
hinge on the effect of the decision on the maximization of shareholder
wealth given the objective of financial management of maximizing present
values. The firm should be guided by the consideration as to which
alternative use is consistent with the goal of wealth maximization that is
the firm consideration as to which alternative use is goal of wealth
maximization that is the firm is well advised to use net profits for paying
dividends to the shareholders if the payment will lead to maximization of
wealth of the owners if not the firm should rather them to finance
investments programs. The relationship between dividends and the value
of the firm should, therefore be the decision criterion
There are however conflicting opinions regarding the impact of dividends
on the value of the firm. According to one school of thought dividends are
irrelevant so that the amount of dividends paid has no effects on the
valuation of a firm. On the other hand certain theories consider the
dividend decision as relevant of the value of the firm measured in terms of
the market price of the shares
The value of the firm can be maximized if the shareholders wealth is
maximized there are conflicting views regarding the impact of dividend
decision on the value of the firm. According to one school of thought
dividend decision does not affect the shareholder’s wealth and hence the
valuation of the firm. On the other hand according to the other school of
thought, dividend decision materially affects the shareholder wealth and
also valuation of the firm
The relevance concept of dividend includes:
1,Walters approach
2,Gordon’s approach

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The irrelevance concept of dividend includes:
1,Residual approach
2,Modigliani and miller approach (mm model)
Walters model:
Prof. Walters approach support the doctrine decisions are relevant and
affect the value of the firm. The relationship between the internal rate of
return earned by the firm and the cost of capital is very significant in
determining the dividend policy to sub serve the ultimate goal of
maximizing the wealth of the shareholders. Prof. Walters model is based
on the relationship between the firms
1,return on investment (r)
To cost of capital k
According to prof. Walter if r > k if the firm earns higher rate of return in
its investment than the required rate of return the firm should retain
earnings, such firms are termed as growth firm and the optimum payout
would be zero in the case. This would maximize the value of shares.
In case of declining firms which do not have profitable investments where
are, r < k the shareholders would stand to gain if the firm distributes its
earnings for such firms the optimum payout would be 100% and the firm
should distribute the entire earnings as dividends.
In case of normal firms where r=k the dividend policy will not affect the
market value of shares. As the shareholders will get the same return as
expected by them for such firms there is no optimum dividend payout and
the value of the firm would not change with the change in dividend rate.
P
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D
K
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g
Where:
P
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D
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K
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Dividend theory The term dividend theory refers to the part of a company which is distributed by the company among its shareholder after execution of retained earning it is the reward of the shareholder for the investment made by them in the shares for the company.in other word it is retained that a share holder gets from the company out of profit on his shareholding A major decision of financial management is the dividend in the sense that the firm has to choose between distributing the profits to the shareholder and ploughing them back into the business, the choice would obviously hinge on the effect of the decision on the maximization of shareholder wealth given the objective of financial management of maximizing present values. The firm should be guided by the consideration as to which alternative use is consistent with the goal of wealth maximization that is the firm consideration as to which alternative use is goal of wealth maximization that is the firm is well advised to use net profits for paying dividends to the shareholders if the payment will lead to maximization of wealth of the owners if not the firm should rather them to finance investments programs. The relations ...
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