Question

Are dividends relevant in determining share values? Identify one factor that indicates they are, and one that indicates they are not. Give your opinion on this question and why you hold it.

Answer 1

Answer -

Dividend are Paid out to shareholders of the firm from the Net Profits.

Dividend decision requires much Analysis since Net Profit add to the growth of the company in form of retained Earnings. Hence One part of Net profit is distributed to shareholders and Other part is retained by company for future growth.

There are different theories invented on dividend decision. Some theories opined that dividend is important in determining share value and some theories suggest that dividend is not relevant in determining share value.

Factors Effecting the share value

Payout ratio effects the value of Share price. Firm keep the optimum payout ratio for dividend distribution

Firms need to keep payout ratio of 0% in case rate of return is higher than cost of capital. If Rate of return is higher that cost of capital than shareholders earning more than required cost of capital hence Whole dividend will be retained for future growth hence payout ratio will be 0%.

If return rate is less than required cost of capital then shareholders will require 100% payout since earning will be lesser than cost of capital

Hence Optimal Payout ratio effect the decision of dividend ultimately effecting the share price.

Factors Not effecting the share value

Dividend is irrelevant in deternining the share price of the firm. only the factors like firms value depends upon Investment policy and and value of firm is not related to how the profit is being distributed in form of dividend.

Explanation - If firm distributes dividend, then shareholders enjoys dividend but will not be equally benefited from equity value since such amount will not become part of Equity.

If Does not distribute dividend then whole amount will becomes part of equity and shareholders will ultimately enjoys increased capital/equity instead of Dividend