dividend decision

FINANCIAL MANAGEMENT (MBA – 2 SEM)

CAREER POINT UNIVERSITY

KOTA (Raj.)

FINANCIAL MANAGEMENT

“A Report on Dividend Decision & Valuation of the Firm”

Submitted To- Submitted By-Miss Pragya Bhargav Barkha Daswani (K13517)

(Asst. Prof. of School Surbhi Hada (K13239)

Of Commerce and MGMT) Ravi Singh (K13389)

Ashim Roy (K13226)

Varsha Singh (K13560)

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ACKNOLODGEMENT

We would like to express our special thanks of gratitude to our teacher Miss.

Pragya Bhargav as well as our HOD Mr. Ashish Suri Sir who gave us the golden

opportunity to do this wonderful project on the topic “Dividend Decision & Valuation

of the Firm”, which also helped us in doing a lot of Research and we came to know

about so many new things. We are really thankful to them. Secondly we would also like

to thank our parents and friends who helped us a lot in finishing this project within the

limited time.

We are also making this Assignment not only for marks but also to increase our

knowledge.

THANKS AGAIN TO ALL WHO HELPED US.

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INDEX

Introduction PG. 04

Irrelevance of dividend policy PG. 05

Miller and Modigliani theory on Dividend Policy PG. 05

Residual theory of Dividend Policy PG. 07

Relevance of dividend policy PG. 08

Walter’s Model PG. 08

Gordon’s Model PG. 10

Dividend Policy PG. 12

Importance of Dividend Policy PG. 13

Aditya Birla Group PG. 15

A.V. NUVO PG. 16

Dividend Summary PG. 17

Conclusion

Bibliography PG. 18

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INTRODUCTION

The Dividend Policy is a financial decision that refers to the proportion of the firm’s earnings to be

paid out to the shareholders. Here, a firm decides on the portion of revenue that is to be distributed to the

shareholders as dividends or to be ploughed back into the firm.

The amount of earnings to be retained back within the firm depends upon the availability of investment

opportunities. To evaluate the efficiency of an opportunity, the firm assesses a relationship between the rate

of return on investments “r” and the cost of capital “K.”

As per the dividend models, some practitioners believe that the shareholders are not concerned with the

firm’s dividend policy and can realize cash by selling their shares if required. While the others believed that,

dividends are relevant and have a bearing on the share prices of the firm. This gave rise to the following

models:

1. Miller and Modigliani Hypothesis- Dividend Irrelevance Theory

2. Walter’s Model – Dividend Relevance Theory

3. Gordon’s Model- Dividend Relevance Theory

As long as returns are more than the cost, a firm will retain the earnings to finance the projects, and the

shareholders will be paid the residual dividends i.e. the earnings left after financing all the potential

investments. Thus, the dividend pay-out fluctuates from year to year, depending on the availability of

investment opportunities.

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Irrelevance of dividend policy:

The dividend irrelevance theory is a theory that investors are not concerned with a company's

dividend policy since they can sell a portion of their portfolio of equities if they want cash. Two

important theories discussed relating to the irrelevance approach, the residuals theory and the

Modigliani and Miller approach.

Miller and Modigliani theory on Dividend Policy

According to Miller and Modigliani Hypothesis or MM Approach, dividend policy has no effect on

the price of the shares of the firm and believes that it is the investment policy that increases the firm’s share

value.

The investors are satisfied with the firm’s retained earnings as long as the returns are more than the

equity capitalization rate “Ke”. What is an equity capitalization rate? The rate at which the earnings,

dividends or cash flows are converted into equity or value of the firm. If the returns are less than “Ke” then,

the shareholders would like to receive the earnings in the form of dividends.

Assumptions of Miller and Modigliani Hypothesis:

1. There is a perfect capital market, i.e. investors are rational and have access to all the information

free of cost. There is no floatation or transaction costs, no investor are large enough to influence the

market price, and the securities are infinitely divisible.

2. There are no taxes. Both the dividends and the capital gains are taxed at the similar rate.

3. It is assumed that a company follows a constant investment policy. This implies that there is no

change in the business risk position and the rate of return on the investments in new projects.

4. There is no uncertainty about the future profits, all the investors are certain about the future

investments, dividends and the profits of the firm, as there is no risk involved.

Criticism of Miller and Modigliani Hypothesis:

1. It is assumed that a perfect capital market exists, which implies no taxes, no flotation, and the

transaction costs are there, but, however, these are untenable in the real life situations.

2. The Floatation cost is incurred when the capital is raised from the market and thus cannot be

ignored since the underwriting commission, brokerage and other costs have to be paid.

3. The transaction cost is incurred when the investors sell their securities. It is believed that in case no

dividends are paid; the investors can sell their securities to realize cash. But however, there is a cost

involved in making the sale of securities, i.e. the investors in the desire of current income has to sell

a higher number of shares.

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4. There are taxes imposed on the dividend and the capital gains. However, the tax paid on the

dividend is high as compared to the tax paid on capital gains. The tax on capital gains is a deferred

tax, paid only when the shares are sold.

5. The assumption of certain future profits is uncertain. The future is full of uncertainties, and the

dividend policy does get affected by the economic conditions.

Thus, the MM Approach posits that the shareholders are indifferent between the dividends

and the capital gains, i.e., the increased value of capital assets.

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Residuals theory of dividends

One of the assumptions of this theory is that external financing to re-invest is either not available, or

that it is too costly to invest in any profitable opportunity. If the firm has good investment opportunity

available then, they'll invest the retained earnings and reduce the dividends or give no dividends at all. If no

such opportunity exists, the firm will pay out dividends.

If a firm has to issue securities to finance an investment, the existence of floatation costs needs a larger

amount of securities to be issued. Therefore, the pay out of dividends depend on whether any profits are left

after the financing of proposed investments as floatation costs increases the amount of profits used. Deciding

how much dividends to be paid is not the concern here, in fact the firm has to decide how much profits to be

retained and the rest can then be distributed as dividends. This is the theory of Residuals, where dividends

are residuals from the profits after serving proposed investments.

This residual decision is distributed in three steps:

o Evaluating the available investment opportunities to determine capital expenditures.

o Evaluating the amount of equity finance that would be needed for the investment, basically having

an optimum finance mix.

o Cost of retained earnings<cost of new equity capital, thus the retained profits are used to finance

investments. If there is a surplus after the financing then there is distribution of dividends.

Extension of the theory:

The dividend policy strongly depends on two things:

o Investment opportunities available to the company

o Amount of internally retained and generated funds which lead to dividend distribution if all possible

investments have been financed.

The dividend policy of such a kind is a passive one, and doesn't influence market price. The dividends

also fluctuate every year because of different investment opportunities every year. However, it doesn't really

affect the shareholders as they get compensated in the form of future capital gains.

Conclusion:

The firm paying out dividends is obviously generating incomes for an investor, however even if the firm

takes some investment opportunity then the incomes of the investors rise at a later stage due to this profitable

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Relevance Dividend Theory:

Dividends paid by the firms are viewed positively both by the investors and the firms. The

firms which do not pay dividends are rated in oppositely by investors thus affecting the share price.

The people who support relevance of dividends clearly state that regular dividends reduce uncertainty

of the shareholders i.e. the earnings of the firm is discounted at a lower rate, ke thereby increasing the

market value. However, its exactly opposite in the case of increased uncertainty due to non-payment of

dividends.

Two important models supporting dividend relevance are given by Walter and Gordon.

Walter’s Model

According to the Walter’s Model, given by prof. James E. Walter, the dividends are relevant and have

a bearing on the firm’s share prices. Also, the investment policy cannot be separated from the dividend

policy since both are interlinked.

Walter’s Model shows the clear relationship between the return on investments or internal rate of return (r)

and the cost of capital (K). The choice of an appropriate dividend policy affects the overall value of the firm.

The efficiency of dividend policy can be shown through a relationship between returns and the cost.

1. If r>K, the firm should retain the earnings because it possesses better investment opportunities and

can gain more than what the shareholder can by re-investing. The firms with more returns than a

cost are called the “Growth firms” and have a zero pay-out ratio.

2. If r<K, the firm should pay all its earnings to the shareholders in the form of dividends, because

they have better investment opportunities than a firm. Here the pay-out ratio is 100%.

3. If r=K, the firm’s dividend policy has no effect on the firm’s value. Here the firm is indifferent

towards how much is to be retained and how much is to be distributed among the shareholders. The

pay-out ratio can vary from zero to 100%.

Assumptions of Walter’s Model:

1. All the financing is done through the retained earnings; no external financing is used.

2. The rate of return (r) and the cost of capital (K) remain constant irrespective of any changes in the

investments.

3. All the earnings are either retained or distributed completely among the shareholders.

4. The earnings per share (EPS) and Dividend per share (DPS) remains constant.

5. The firm has a perpetual life.

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Criticism of Walter’s Model:

1. It is assumed that the investment opportunities of the firm are financed through the retained

earnings and no external financing such as debt, or equity is used. In such a case either the

investment policy or the dividend policy or both will be below the standards.

2. The Walter’s Model is only applicable to all equity firms. Also, it is assumed that the rate of return

(r) is constant, but, however, it decreases with more investments.

3. It is assumed that the cost of capital (K) remains constant, but, however, it is not realistic since it

ignores the business risk of the firm, that has a direct impact on the firm’s value.

Note: Here, the cost of capital (K) = Cost of equity (Ke), because no external source of financing is used.

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Gordon’s Model

The Gordon’s Model, given by Myron Gordon, also supports the doctrine that dividends are relevant to

the share prices of a firm. Here the Dividend Capitalization Model is used to study the effects of dividend

policy on a stock price of the firm.

Gordon’s Model assumes that the investors are risk averse i.e. not willing to take risks and prefers

certain returns to uncertain returns. Therefore, they put a premium on a certain return and a discount on the

uncertain returns. The investors prefer current dividends to avoid risk; here the risk is the possibility of not

getting the returns from the investments.

But in case, the company retains the earnings; then the investors can expect a dividend in future. But the

future dividends are uncertain with respect to the amount as well as the time, i.e. how much and when the

dividends will be received. Thus, an investor would discount the future dividends, i.e. puts less importance

on it as compared to the current dividends.

According to the Gordon’s Model, the market value of the share is equal to the present value of future

dividends. It is represented as:

P = [E (1-b)] / Ke-br

Where, P = price of a share

E = Earnings per share

b = retention ratio

1-b = proportion of earnings distributed as dividends

Ke = capitalization rate

Br = growth rate

Assumptions of Gordon’s Model:

1. The firm is an all-equity firm; only the retained earnings are used to finance the investments, no

external source of financing is used.

2. The rate of return (r) and cost of capital (K) are constant.

3. The life of a firm is indefinite.

4. Retention ratio once decided remains constant.

5. Growth rate is constant (g = br)

6. Cost of Capital is greater than br

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Criticism of Gordon’s Model:

1. It is assumed that firm’s investment opportunities are financed only through the retained earnings

and no external financing viz. Debt or equity is raised. Thus, the investment policy or the dividend

policy or both can be sub-optimal.

2. The Gordon’s Model is only applicable to all equity firms. It is assumed that the rate of returns is

constant, but, however, it decreases with more and more investments.

3. It is assumed that the cost of capital (K) remains constant but, however, it is not realistic in the real

life situations, as it ignores the business risk, which has a direct impact on the firm’s value.

Thus, Gordon model posits that the dividend plays an important role in determining the share price of the firm.

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Dividend Policy

Firm’s dividend policy divides net earnings into retained earnings and dividends. Retained

earnings provide necessary funds to finance long term growth while dividends are paid in cash

generally. Dividend policy of the firm is governed by:

(i) Long Term Financing Decision:

When dividend decision is treated as a financing decision, net earnings are viewed as a source

of long term financing. When the firm does not have profitable investment opportunities, dividend

will be paid. The firm grows at a faster rate when it accepts highly profitable opportunities. External

equity is raised to finance investments. But retained earnings are preferable because they do not

involve floatation costs. Payment of cash dividend reduces the amount of funds necessary to finance

profitable investment opportunities thereby restricting it to find other avenues of finance. Thus

earnings may be retained as part of long term financing decision while dividends paid are

distribution of earnings that cannot be profitably re-invested.

(ii) Wealth Maximisation Decision:

Because of market imperfections and uncertainty, shareholders give higher value to near

dividends than future dividends and capital gains. Payment of dividends influences the market price

of the share. Higher dividends increase value of shares and low dividends decrease it. A proper

balance has to be struck between the two approaches. When the firm increases retained earnings,

shareholders' dividends decrease and consequently market price is affected. Use of retained

earnings to finance profitable investments increases future earnings per share.

On the other hand, increase in dividends may cause the firm to forego investment opportunities

for lack of funds and thereby decrease the future earnings per share. Thus, management should

develop a dividend policy which divides net earnings into dividends and retained earnings in an

optimum way so as to achieve the objective of wealth maximization for shareholders. Such policy

will be influenced by investment opportunities available to the firm and value of dividends as

against capital gains to shareholders.

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Importance of Dividend Policy:

Shareholders look into the capability of companies to initiate a dividend. Dividends are

payments made by a company to a shareholder usually after a company earns a profit. Since dividends

are money divided to shareholders after a profit, it is not considered a business expense but a sharing

of recognized assets among shareholders. Dividends are either paid regularly or can be called out

anytime. Consequently, a dividend policy is a set of company rules and guidelines used to decide how

much the company will pay out to its shareholders.

A dividend policy is first known as a heavy factor in a company’s stock value. However, more

scholars are suggesting that corporate dividend policies do not matter and should not matter in a

company’s stock value. Arguments against dividend policies start from the fact that investors can

create their own dividends on other investment option. A wise investor can look at more stable bonds

to earn a return of investment rather than a dividend policy that can fluctuate. Secondly, earning from

dividends is taxed higher than capital gains. For these reasons, investors are not lured to relative

corporate dividend policies of companies as an accurate value of their stock.

Some companies believe that a no-dividend policy is just as sound as companies with a

dividend policy. Companies without a dividend policy can use their profit earnings to reinvest and

expand the company shares or buy assets. Having a dividend policy foregoes these opportunities.

For people who value profit certainty of a company, a sound dividend policy is important. It

follows that a high and regular corporate dividend policy means that companies have a benchmark for

doing well. Therefore, more dividends can equate to the overall health of the company. Dividend

policies are more valuable to small companies or cooperatives with excess cash and a few good

projects where the net present value of these projects is positive. Meanwhile companies, without

excess cash but have several good projects where NPV is also positive will only derail the undertaking

of current projects. While a good corporate dividend policy is equated to excess cash, the value of the

company is not hinged on the value of dividends as there are other indicators of a company’s

performance.

There are different kinds of dividend policies. First, residual dividend policy is a method of

distribution where dividends are paid after all the requirements for capital are met. Thus, dividends are

computed from the residual cash after spending on new capital goods. The aim of this dividend policy

is to decide if there is enough money left after all costs are met.

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A cyclical policy or stable policy is a regular dividend pay-out usually given every quarter. A

cyclical dividend policy is set at a fixed fraction of quarterly earnings while a stable policy is set as a

fraction of yearly earnings. This produces certainty for investors that they get regular income for their

investments.

In the end, the value of dividend policies falls on investor decisions. While there are contrasting views

of its usefulness, the most important factor is achieving the best bang-for-buck.

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A V Birla Group

Introduction

The Aditya Birla Group is an Indian multinational conglomerate named after Aditya Vikram

Birla, headquartered in the Aditya Birla Centre in Worli, Mumbai, India. It operates in 40 countries

with more than 120,000 employees worldwide. The group was founded by Seth Shiv Narayan Birla in

1857. The group interests in sectors such as viscose staple fibre, metals, cement (largest in India),

viscose filament yarn, branded apparel, carbon black, chemicals, fertilisers, insulators, financial

services, telecom (third largest in India), BPO and IT services.

The group had revenue of approximately US$41 billion in year 2015. It is the third-largest

Indian private sector conglomerate behind Tata Group with revenue of just over US$100 billion

and RIL with revenue of US$74 billion.

A US $41 billion (Rs. 2, 50,000 corers) corporation, the Aditya Birla Group is in the League

of Fortune 500. Anchored by an extraordinary force of over 120,000 employees, belonging to 42

nationalities. Over 50 per cent of its revenues flow from its overseas operations spanning 36 countries.

The Aditya Birla Group has been ranked fourth in the world and first in Asia Pacific in the

‘Top Companies for Leaders’ study 2011, conducted by Aon Hewitt, Fortune Magazine and RBL (a

strategic HR and leadership Advisory firm). The Group has topped the Nielsen's Corporate Image

Monitor 2014-15 and emerged as the Number one corporate, the 'Best in Class', for the third

consecutive year.

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https://en.wikipedia.org/wiki/Reliance_Industries

https://en.wikipedia.org/wiki/Tata_Group

https://en.wikipedia.org/wiki/Mumbai

https://en.wikipedia.org/wiki/Worli

https://en.wikipedia.org/wiki/Aditya_Vikram_Birla

https://en.wikipedia.org/wiki/Aditya_Vikram_Birla

https://en.wikipedia.org/wiki/Conglomerate_(company)

https://en.wikipedia.org/wiki/Multinational_corporation

https://en.wikipedia.org/wiki/India


Aditya Birla Nuvo:

Aditya Birla Nuvo Limited (ABNL), a US$4 billion conglomerate by revenue size, is part of the

Aditya Birla Group, a US$41 billion Indian multinational, operating in 36 countries across the globe.

With a market cap of ~US$3.5 billion (30 September 2014), Aditya Birla Nuvo is present across

Financial Services, Telecom, Fashion and Lifestyle and Manufacturing Businesses.

Business areas:

The razor-sharp focus on each business has made the company a leading player in most

segments, including viscose filament yarn, apparel brands, agri business, textiles and insulators. Over

the last few years, Aditya Birla Nuvo, through its subsidiaries and joint ventures, has created a

leadership position in consumer centric businesses such as life insurance, asset management, lending

and other financial services and telecom.

As a leading conglomerate in India, Aditya Birla Nuvo ranks as:

The second-largest producer and largest exporter of viscose filament yarn.

The largest branded apparel company offering the best apparel brands in India.

The largest linen fabric manufacturer in India.

Amongst the most energy-efficient fertiliser plants.

India's largest and the world's fourth-largest manufacturer of insulators.

Joint ventures and subsidiary companies:

Idea Cellular Limited is among the top three cellular operators in India, in terms of revenue

market share.

Birla Sun Life Insurance Co. Limited is among the top five private sector life insurance

companies in India, in terms of assets under management.

Birla Sun Life Asset Management Co. Limited is the fourth largest asset management company

in India, in terms of assets under management.

Pantaloons Fashion & Retail Limited is among the top three large format fashion retailers in

India.

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Dividend Summary:

For the year ending March 2016, Aditya Birla Nuvo has declared an equity dividend of 50.00%

amounting to Rs 5 per share. At the current share price of Rs 1519.65 this result in a dividend yield of

0.33%.

The company has a good dividend track report and has consistently declared dividends for the

last 5 years.

* As per the Profit & Loss account

Dividend Declared

AnnouncementDate

EffectiveDate

DividendType

Dividend(%)

Remarks

20-05-16 16-08-16 Final 50.00 Rs.5.0000 per share(50%)Dividend






07-05-10 29-07-10 Final 50.00 -

28-04-09 02-07-09 Final 40.00 -

30-04-08 03-07-08 Final 57.50 AGM

05-03-07 20-03-07 Interim 55.00 -

28-04-06 08-08-06 Final 50.00 AGM

27-04-05 09-06-05 Final 40.00 AGM

29-04-04 17-06-04 Final 40.00 AGM

28-04-03 17-07-03 Final 37.50 AGM

06-05-02 15-07-02 Final 33.00 -

27-04-01 21-05-01 Final 30.00 -

Source: http://www.moneycontrol.com/company-facts/adityabirlanuvo/dividends/ABN01

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Conclusion:

Many investors seek dividend-paying stocks as a means of generating income and growing wealth. As with any investment, it is important to do your homework and find investments that are suitable to your investing style, time horizon, financial situation and financial objectives. A variety of resources and tools are available in print and online to help you make investment decisions. You can consult with qualified financial planners and tax specialists to determine the best course of action for your investment strategy.

Bibliography:

www.investopedia.com

www.google.com

www.businessjagrons.com

www.wikipedia.com

MILLER MODIGLIANI JAMES WALTER GORDON

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http://www.wikipedia.com/

http://www.businessjagrons.com/

http://www.google.com/

http://www.investopedia.com/

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