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| corporate practice bd |
Dividend Policy-With Practical Examples:
Dividend policy refers to the guidelines and decisions a company makes regarding the distribution of its profits to its shareholders in the form of dividends. Dividends are typically paid out of a company's earnings and represent a portion of the profits that are returned to the shareholders.
There are several key aspects and considerations associated with dividend policy:
Dividend Payment Frequency:
Companies can choose to pay dividends on a regular basis, such as quarterly, semi-annually, or annually. The frequency of dividend payments depends on the company's financial performance and its desire to provide a steady income stream to shareholders.
Dividend Yield:
Dividend yield is the ratio of annual dividends per share to the stock's current market price. It's an important metric for investors looking for income from their investments.
Dividend Payout(D/P) Ratio:
This ratio indicates the percentage of earnings that a company pays out to shareholders in the form of dividends. A higher payout ratio means a larger proportion of earnings is being distributed as dividends.
Stability of Dividends:
Some companies strive to maintain a stable dividend policy by paying out a consistent amount of dividends regardless of fluctuations in earnings. This approach is appealing to income-focused investors.
Dividend Growth:
Other companies focus on gradually increasing dividends over time, which can attract investors seeking both current income and potential for future growth.
Retained Earnings:
Instead of distributing all profits as dividends, some companies retain a portion of their earnings to reinvest in the business for growth and expansion. This can be particularly common among younger companies in high-growth industries.
Cash Flow and Financial Health:
A company's ability to pay dividends is closely tied to its cash flow and financial health. Sustainable dividends depend on consistent and sufficient cash flow generation.
Legal and Regulatory Considerations:
Dividend distributions are subject to legal and regulatory requirements in the company's jurisdiction. Companies must ensure compliance with laws and regulations governing dividend payments.
Investor Preferences:
Companies often consider the preferences of their investors when determining dividend policy. Different investors may have varying preferences for income versus capital appreciation.
Market Perception:
Dividend announcements can influence the market's perception of a company's financial stability and growth prospects. Companies often strategize their dividend policies to send positive signals to investors.
It's important to note that dividend policy is not set in stone and can change over time based on a company's financial performance, strategic goals, and market conditions. Investors should consider a company's dividend policy alongside other factors when making investment decisions.
Dividend Policy
A dividend policy is the policy a company uses to structure its dividend payout to shareholders.
Some Abbreviation:
Ke = cost of equity/capitalization rate
b =Retention ratio
G =growth rate
P0 =Market price per share /Price per share/value of the share
D/DPS =Dividend per share
E/EPS =Earnings per share
R = Internal rate of return/Rate of return/required rate
P/E ratio = Price earning ratio
Note: Optimum payout ratio (qualification criteria)
1. When rate of return(r) is grater than cost of equity(ke) that means( r>ke)Then,
***Optimum pay out ratio will be(0%)***
2. When rate of return(r) is equal to cost of equity(ke) that means( r = ke)Then,
***Optimum pay out ratio will be(50%)***
(Under M .M Model)
Δn =No of share issue
I= new Investment
E = Earning/Profit
V=Market value of the firm
P0=Present value of the share
P1= Market price end of the year /next year
N =number of share
r = Internal rate of return/Rate of return/Required rate
D0=Dividend current yearSome important formulas:
7.Optimum payout Ratio =R>Ke=0< R<Ke=100%, R=Ke=50%
9. EPS= Face value of share* internal rate of return(r)
[M.M. Model (Formula)]
08.No.of new share issue ( Δ n ) = (I - E + nD1) /p1
09.External Financing = I - E + nD1
10.Market value of the firm(V)= (n+Δn)p1-I+E / 1+Ke
11.Present value of the share(po) = p1/(1+Ke)-D
Practical
Example-01 (Normal way)
Following information are available
Market per share= Tk.400.00
Earning per share(EPS) =Tk 25.00
Dividend per share=Tk.10.00
Price earnings ratio(P/E) ratio = 8 times
Requirement: (Using Walter Model)
(i)Cost equity(ke)
(ii) D/P ratio
(iii)Retention ratio
(iv) Internal rate of return(r)
(v) Growth rate(g)
(vi) optimum payout ratio
Solution
We know that,
(i) Cost equity(ke) =( 1/8)*100
= 12.50%(Ans)
(ii) D/P ratio =DPS/EPS *100
= 10/25 *100
= 0.40 or,40%
(iii) Retention ratio(b)=1-D/P ratio
= 1-.40
= .60 or,60%
(iv)According to Walter model:
To find out Internal rate of return(r), at first we have to calculate Market price per share(P0) formula by following way-
We know that,
Market price per share(P0) = D+(R/Ke)(E−D) /Ke
Or,400 = 10+(R/.125)(25−10) /.125
Or, 400 *.0125 = 10+ 15*r/.125
Or, 50-10 = 120*r
Or, r = 40/120
Or, r = .3333
or, 33.33%
(v) Growth rate(g) = b*r
= .60*.3333
=.19998 or,20%
(vi) Optimum payout ratio: Since r>Ke (33.33%>12.50%)so,
Optimum payout ratio will be Zero (0)
Practical Example-02
XYX company. has the following information –
Earnings per share (EPS) =Tk 20.00
Dividend per share=Tk.10.00
Price earnings ratio(P/E) ratio =6.25 times
Rate of return (r) = 16%
Requirement: (Using Gordon’s Model)
(i)Cost equity(ke)
(ii) D/P ratio
(iii)Retention ratio
(iv)Market price per share(p0)
(v) Growth rate(g)
(vi) Optimum payout ratio
Solution:
(i)Cost equity (Ke) =(1/PE)*100
=(1/6.25)*100
= 16%
(ii)D/P ratio =( 1/ PE )*100
= .50 or, 50%
(iii)Retention ratio=1-D/P ratio
= 1-.50
= .50 or,50%
(iv)P0 = E(1-b) /(Ke-br) [ According to Gordons Model]
=(20(1-0.50))/(0.16-0.50)
= Tk.125(Ans)
(v) Growth rate(g) = b*r
= .50*0.16
=0.08 or,8%
(vi) Optimum payout ratio: Since r = ke
(16% = 16%) so, Optimum payout ratio will be (50%).
Practical Example-03
ABC company LTD. has the following information –
Earnings per share (EPS) = T k 10.00
Internal rate of return = 15%,10%,8%
Price earnings ratio(P/E) ratio = 6.25 times
Capitalization rate = 10.00
Retention rate (b) = 40%%
Calculate the following requirement
1.Calculate market price per share (Using Walter & Gordons Model)
(Where, Internal rate of return = 15%,10%,8%)
Solution:
We know that (Under Walter Model)
Here,
EPS=10, b=40% or,0.40,
D/P ratio=100%-retention ratio
Dividend(Do) =EPS*60%=10*60%=Tk.6
When r =15% then,
Market price per share(P0) = D+(R/Ke)(E−D) /Ke [ According to Walters Model]
P0 =6+(0.15/0.10)(10−6) /0.10
P0 =6+1.50*4/0.10
=Tk.120(Ans)
[ According to Gordons Model)
When r =15% then,
P0 = E(1-b) /Ke-br
=10(1-0.40)/ 0.10-(0.40*0.15)
=6/0.04
= 150 (Ans)
When r =10% then,
P0 = E(1-b) /Ke-br
=6+(0.10/0.10/(10-6)/0.10
=6+1*4/0.10
= 100 (Ans)
[ According to Walters Model]
When r =8% then,
Market price per share(P0) = D+(R/Ke)(E−D) /Ke [ According to Walters Model)
P0 =6+(0.08/0.10)(10−6) /0.10
P0 =6+0.08*4/0.10
=Tk.92 (Ans)
[ According to Gordons Model)
When r =8% then,
P0 = E(1-b) /(Ke-br)
=10(1-0.40)/(0.10-0.40)*0.08
=10*0.60/(0.10-0.032)
=6/0.068
= 88.24 (Ans)
Practical Example-04
The wimax company: TD. Which earns Tk.15 per share is capitalized at 10% and has return on investment at 12%. Find out the price of the share at optimum payout ratio by using Walter & Gordons Model.
Here,
E =Tk.15, R=12% or ,0.12 Ke=10% or ,0.10
Since R>ke , or, 12%>10% so
D/P ratio=0%,D=15*0% =Tk.0
[ According to Walters Model)
Market price per share(P0) = D+(R/Ke)(E−D) /Ke [ According to Walters Model)
P0 =0+(0.12/0.10)(15−0) /0.10
P0 =0+(1.2*15)/0.10
= 18/0.10
=Tk.180 (Ans)
[ According to Gordons Model)
Here,
Assume, D/P Ratio=50%,
E =Tk.15, R=12% or ,0.12 Ke=10% or ,0.10
Since R>ke , or, 12%>10%
B(retention ratio) =(1-D/P ratio
b=(1.0.50)= .050 or,50%
D=15*50% =Tk.7.50
[ According to Gordons Model]
P0 = E(1-b) /(Ke-br)
= 15(1-0.50)/(0.10-(0.50*0.12)
= 10*0.60/(0.10-0.032)
= 7.50/0.04
= 187.50 (Ans)Practical Example-05
Following information are available-
Here Market price per share =Tk.200
EPS = Tk.12.50
DPS = Tk.5
Price earnings ratio(P/E) = 4 times
Required (using Walter Model)
(a) Cost of equity(ke)
(b) Dividend Payout ratio
(c) Retention ratio
(d) Internal rate of return
Solution:
(a)Cost equity (Ke) = (1/4)*100
= (1/4)*100
= 25%
(b)Dividend Payout ratio (D/P ratio) = (DPS/EPS )*100
= (5/12.50)*100
= .40
or, 40%
(C ) Retention ratio=1-D/P ratio =1-.40
= .60 or,60%
(d) Internal rate of return (According to Walter Model
We know that,
Here,
D =5 ,E=12.50 Ke=25% or,0.25 ,Po= Tk.200 r=?
[ According to Walters Model]
We know that,
Market price per share(P0) = D+(R/Ke)(E−D) /Ke
Or,200 = 5+(R/.25)(12.50−5) /.125
Or, 200 *.025 =5+ 7.5*r/0.25
Or, 50-5 = 30*r
Or, r = 45/30
Or, r =1.50
or, r =150%
Practical Example-06
Zerin company earns Tk.6 per share, is capitalized at rate of 10% and has rate of return on investment of 22%.
According to Walter model, what should be the price per share at 15% dividend.
[ According to Walters Model)
Market price per share(P0) = D+(R/Ke)(E−D) /Ke
= 0.90+(0.22/0.10)(6−0.90) /0.10
= (.90+2.20)*5.10 /0.10
=Tk.121.2(Ans)
Practical Example-07
ABC company Ltd has 10,000 ordinary share outstanding in the market having a face value of per share Tk.100 each. The internal rate of return is 16% and capitalization rate is 12%. What would be the market price of the share, if the dividend payout ratio is 50% and 80%? (use Walter model)
Here,
EPS=100*16%=Tk.16, D/P ratio =50%, D/DPS=16*50% = Tk.8.00, R=16%,Ke=12%
[ According to Walters Model)
Market price per share(P0) = D+(R/Ke)(E−D) /Ke
= 8+(0.16/0.12)(16−8) /0.12
= (.90+2.20)*5.10 /0.10
=Tk.155.56 (Ans)
When D/P ratio =80% then,
Po =D+(R/Ke)(E−D) /Ke
= 12.8+(0.16/0.12)(16−12.80) /0.12
= Tk.142.22 (Ans)
Practical Example-08
M.M Model (Modigliani & Miller)
Corporate practice bd LTD, has outstanding 1,00,000 share. The company needs Tk.7,00,000 to financing its investment for which Tk.1,00,000 is available out of profit. The market price per share at the end of current year is expected to be Tk.150. Dividend rate is 20%
Requirement (Under M.M Model)
1.Number of new share issues
2.External financing
3.Market value of the firm
4.Present value of the firm
5.Prove: P1=P0(1+Ke)-D1
Solution:
1.No.of new
share issue ( Δ n ) = I -E+ND1 /P1
= 7,00,000-1,00,000+(1,00,000*0)/150
= 4,000 share(Ans)
2.External Financing = I-E+nD1
= 7,00,000-1,00,000+(1,00,000*0)
= Tk. 6,00,000 (Ans)
3.Market value of the firm(V) = (n+Δn)p1-I+E /1+Ke
= (1,00,000+4,000)150-7,00,000+1,00,000)/ 1+.20
= Tk.1,25,00,000 (Ans)
4.present value of the share (Po) = p1/(1+Ke)-D
= 150/(1+.20)-0
= Tk.125(Ans)
5. Prove: P1 = P0(1+Ke)-D1
or, P1 = P0(1+Ke)-D1
= 125 (1+.20)-0
= 150 (proved)
Practical Example-09
The ABC Company has cost equity capital of 15%. The current market value of the firm is Tk.30,00,000@ Tk.30 per share. Show under M.M assumption the payment of Dividend does not affect the value of the firm.
Additional information
New investment (I) = 9,00,000
Earning(E) = 50,0000
Total dividend(D) = 3,00,000
Requirement:
1.Number of share?
2.Dividend payout ratio?
Solution:
1.Number of share =30,00,000/30
= 1,00,000
2.Dividend payout ratio D1(DPS) =30,00,000/10,00,000 =3
Here,
Ke =15%, Or,0.15, Value=30,00,000, Po=30, I=9,00,000, E=5,00,000, NS=1,00,000, D1(DPS)=3
When dividend is paid] Then ,
[Here, Market price at the end of the year (P1)= P0(1+Ke)- D1
= 30(1+0.15)-3
= 31.50
= {(1,00,000+22,222)*31.50}-9,00,000+5,00,000/1+0.15
= (1,22,222 *31.50)-9,00,000+5,00,000/1+0.15
= 38,49,993-4,00,000/1.15
= 34,49,993/1.15
= Tk.30,00,000 (Ans)
When dividend
is not paid] then,
Market price at the end of the year (P1) = P0(1+Ke)- D1
= 30(1+0.15)-0
= 34.50
= (1,00,000+11,594)*34.50-9,00,000+5,00,000/1+0.15
= (1,11,594*34.50)-4,00,000 /1.15So, we can say that value of the firm remains same whether or not dividend is paid.
Practical Example-10
The corporate practiced bd Ltd has cost equity capital of 12%. The current market value of the firm is Tk.25,00,000@ Tk. 25 per share.
Dividend is paid at the end of the year. Show under M.M assumption the payment of Dividend does not affect the value of the firm.
Additional information
New investment (I) = 7,00,000
Earning(E) = 3,00,000
Total dividend(D) = Tk.2.00 per share
[When dividend is paid] then,]
Here,
Market price at the end of the year (P1) = P0(1+Ke)- D1
= 25(1+0.12)-2
= 26
No.of new share issue(Δn) = I-E+nD1/P1
= (1,00,000+23,077.92)*26-7,00,000+3,00,000 /1+0.12
= ( 123077.92*26)-7,00,000+3,00,000 /1.12[When dividend is not paid] then,]
[Here, P1= P0(1+Ke)- D1
= 25(1+0.12)-0
= 28
Δn = I-E+nD1/P1
Market value of the firm (V) = (n+Δn)p1-I+E /1+Ke
= (1,00,000+14,286)*28-7,00,000+3,00,000 /1+0.12
= (1,14,286*28)-4,00,000 /1.12So, we can say that ,value of the firm remains same whether or not dividend is paid.
Practical Example-11
The XYZ company ltd. Has the following stockholders Account:
|
Common stock(Tk.10per share |
10,00,000 |
|
10% preferred stock |
8,00,000 |
|
Retained earning |
7,00,000 |
|
Total shareholders’ equity |
25,00,000 |
Requirement:
What will be happen to this account and to the number of shares outstanding with? if,
(1) A 10% stock dividend is paid
(2) A 2 for 1 stock split effect
(3) A 1 for 2 reverse stock split effect
Solution:
(1) When effect on 10% stock dividend
(W-1) No. share = (10,00,000/10) =1,00,000 share
(W-2) No. of Additional share = 1,00,000*10% = 10,000 share
(W-3)After stock dividend no.of share outstanding=(1,00,000+10,000) =1,10,000 shares.
(W-4) Retained earnings= {7,00,000-(10,000*10)}
= (7,00,000-1,00,000)
[ Effect 10% stock dividend ] = Tk.6,00,000
|
Before stock dividend |
Taka |
After stock dividend |
Taka |
|
Common Stock(1,00,000*10) |
10,00,000 |
Common stock(1,10,000*10) |
11,00,000 |
|
10% Preferred stock |
8,00,000 |
10% Preferred stock |
8,00,000 |
|
Retained earning |
7,00,000 |
Retained earning |
6,00,000 |
|
Total shareholders’ equity |
25,00,000 |
Total shareholders’ equity |
25,00,000 |
(2) Effect on 2:1 stock split
(W-1) No. share = (1,00,000*2) =2,00,000 share
(W-2) Price per share = (10/02) =Tk.5.00
|
Before stock split |
Taka |
After stock split |
Taka |
|
Common Stock(1,00,000*10) |
10,00,000 |
Common Stock(2,00,000*5) |
10,00,000 |
|
10% Preferred stock |
8,00,000 |
10% Preferred stock |
8,00,000 |
|
Retained earning |
7,00,000 |
Retained earning |
7,00,000 |
|
Total shareholders’ equity |
25,00,000 |
Total shareholders’ equity |
25,00,000 |
(3.) A 2 for 1 reverse stock split effect
(W-1) No. share = (25,000*2) =50,000 share
(W-2) Price per share = (10*02) =Tk.20.00
|
Before reverse stock split |
Taka |
After reverse stock split |
Taka |
|
Common stock(1,00,000*10) |
10,00,000 |
Common stock(50000*20) |
10,00,000 |
|
10% Preferred stock |
8,00,000 |
10% Preferred stock |
8,00,000 |
|
Retained earning |
7,00,000 |
Retained earning |
7,00,000 |
|
Total shareholders’ equity |
25,00,000 |
Total shareholders’ equity |
25,00,000 |
“The End”