Question

What is the importance of a firm’s dividend policy? Please explain. Identify the factors that influence the firm’s dividend decision. Be specific.  

Identify, compare, and contrast the major dividend theories that are discussed in your textbook. Be specific.  

Answer 1

IMPORTANCE OF DIVIDEND POLICY

1.Dividends help for stock selection for the investors, because this can facilitate as an income for the investor.

2. A good dividend policy will have a balance between the growth of the company and the distribution to the shareholders

3.It influences the value of the firm

4. It brings a balance between long term financing and the wealth maximisation

FACTORS AFFECTING DIVIDEND DECISION

1. Generally there is no compulsion for the company to pay the dividend by law. But there are certain conditions under the law regarding the way in which the dividend is distributed.

2. Dividend decisions are highly affected by the liquidity position of the company.

3. It is influenced bu the expected rate of return.

4. Stability of earning is also an important factor affecting dividend decision.

MAJOR DIVIDEND THEORIES

The major theories of dividend are:

1.Walter's Model

2.Gordon's Model

3.Mordigiliani and Miller's Model

1.Walter's Model: Here the choice of dividend policies always affects the value of the enterprise.

Its assumptions are:

• The firm finances all investments through retained earnings
• Its IRR and Cost of capital are constant
• All earnings are either distributed as dividend or retained internally
• Beginning earnings and dividends never change
• The firm has infinite life

2.Gordon's Model:

Its assumptions are:

• The company is all equity financed
• There is no external financing
• The IRR is constant
• The discounting rate remains constant
• The stream of earnings are perpetual

3. Mordigiliany and Miller's Hypothesis: According to this model, the dividend policy of a firm is irrelevant and it does not affect the wealth of shareholders.

Its assumptions are:

• There is no tax
• There is fixed investment policy
• The capital market is perfect
• There is no risk of uncertainty