mm approach of dividend policy
TRANSCRIPT
![Page 1: Mm approach of dividend policy](https://reader035.vdocuments.site/reader035/viewer/2022062218/58858cea1a28ab84668b63b3/html5/thumbnails/1.jpg)
Financial Management Seminar
Presented ByRodixon &
Sona
![Page 2: Mm approach of dividend policy](https://reader035.vdocuments.site/reader035/viewer/2022062218/58858cea1a28ab84668b63b3/html5/thumbnails/2.jpg)
“Modigilani- Miller Theory of Dividend Policy” Dividend
Dividend Policy
Valuation
![Page 3: Mm approach of dividend policy](https://reader035.vdocuments.site/reader035/viewer/2022062218/58858cea1a28ab84668b63b3/html5/thumbnails/3.jpg)
Dividend Theories
Relevance Theories(i.e. which consider dividend decision to
be relevant as it affects the value of
the firm)
Walter’s Model
Gordon’s Model
Irrelevance Theories(i.e. which consider
dividend decision to be irrelevant as it does
not affects the value of the firm)
Modigliani and Miller’s
ModelTraditional Approach
![Page 4: Mm approach of dividend policy](https://reader035.vdocuments.site/reader035/viewer/2022062218/58858cea1a28ab84668b63b3/html5/thumbnails/4.jpg)
According to this concept, investors do not pay any importance to the dividend history of a company and thus, dividends are irrelevant in calculating the valuation of a company. This theory is in direct contrast to the ‘Dividend Relevance’ theory which deems dividends to be important in the valuation of a company.
Irrelevance Theory
![Page 5: Mm approach of dividend policy](https://reader035.vdocuments.site/reader035/viewer/2022062218/58858cea1a28ab84668b63b3/html5/thumbnails/5.jpg)
MM Theory
of Dividend Policy
![Page 6: Mm approach of dividend policy](https://reader035.vdocuments.site/reader035/viewer/2022062218/58858cea1a28ab84668b63b3/html5/thumbnails/6.jpg)
Modigliani – Miller theory was proposed by Franco Modigliani and Merton Miller in 1961. They were the pioneers in suggesting that dividends and capital gains are equivalent when an investor considers returns on investment.
The only thing that impacts the valuation of a company is its earnings, which is a direct result of the company’s investment policy and the future prospects.
![Page 7: Mm approach of dividend policy](https://reader035.vdocuments.site/reader035/viewer/2022062218/58858cea1a28ab84668b63b3/html5/thumbnails/7.jpg)
Value of Firm (i.e. Wealth of Shareholders)
Firm’s Earnings
Firm’s Investment Policy and not on dividend policy
![Page 8: Mm approach of dividend policy](https://reader035.vdocuments.site/reader035/viewer/2022062218/58858cea1a28ab84668b63b3/html5/thumbnails/8.jpg)
If a company retains earnings instead of giving it out as dividends, the shareholder enjoy capital appreciation equal to the amount of earnings retained.
If it distributes earnings by the way of dividends instead of retaining it, shareholder enjoys dividends equal in value to the amount by which his capital would have appreciated had the company chosen to retain its earning.
Hence, the division of earnings between dividends and retained earnings is IRRELEVANT from the point of view of shareholders
![Page 9: Mm approach of dividend policy](https://reader035.vdocuments.site/reader035/viewer/2022062218/58858cea1a28ab84668b63b3/html5/thumbnails/9.jpg)
Assumptions of the ModelPerfect Capital Markets: This theory believes in the existence of ‘perfect capital markets’. It assumes that all the investors are rational, they have access to free information, there are no floatation or transaction costs and no large investor to influence the market price of the share.No Taxes: There is no existence of taxes.Fixed Investment Policy: The company does not change its existing investment policy. This means that new investments that are financed through retained earnings do not change the risk and the rate of required return of the firm.No Risk of Uncertainty: All the investors are certain about the future market prices and the dividends.
![Page 10: Mm approach of dividend policy](https://reader035.vdocuments.site/reader035/viewer/2022062218/58858cea1a28ab84668b63b3/html5/thumbnails/10.jpg)
ProofStep 1The market price of a share in the beginning of the period is equal to the present value of dividends paid at the end of the period plus the market price of shares at the end of the period. Symbolically,
P0= 1 ( D1+P1 ) (1 + ke) Where P0= Prevailing market price of a share,
ke= Cost of equity capital D1= Dividend to be received at the end of period 1 and P1 = Market price of a share at the end of period 1.
![Page 11: Mm approach of dividend policy](https://reader035.vdocuments.site/reader035/viewer/2022062218/58858cea1a28ab84668b63b3/html5/thumbnails/11.jpg)
Step 2Assuming no external financing, the total capitalized value of the firm would be simply the number of shares (n) times the price of each share (P0). Thus,
nP0= 1 (nD1+nP1)(1+ke)
Step 3If the firm’s internal source of financing its investment opportunities fall short of the funds required, and n is the number of new shares issued at the end of the year 1 at price of P1 then equation
nP0= 1 [(nD1+(n+∆n)P1-∆nP1)] (1+ke)
![Page 12: Mm approach of dividend policy](https://reader035.vdocuments.site/reader035/viewer/2022062218/58858cea1a28ab84668b63b3/html5/thumbnails/12.jpg)
Step 4If the firm were to finance all investment proposals, the total amount raised through new shares issued would be given in equation
∆nP1= I-(E-nD1)∆nP1= I-E+nD1
∆ nP1= Amount obtained from the sale of new shares of finance capital budget, I= Total amount / Requirement of capital budget E= Earnings of the firm during the periodnD1= total dividend paid outE-nD1= Retained earnings
![Page 13: Mm approach of dividend policy](https://reader035.vdocuments.site/reader035/viewer/2022062218/58858cea1a28ab84668b63b3/html5/thumbnails/13.jpg)
Step 5If we substitute Eq4 into Eq3 we derivenP0= 1 [nD1+(n+∆n)P1-(I-E+nD1)] (1+ke)Solving itnP0=nD1+(n+∆n)P1-I+E-nD1
(1+Ke)There is positive and negative nD1. so nD1 cancels. We then havenP0=(n+ ∆ n)P1-I+E (1+Ke)Step 6 ConclusionSince dividends are not in the final equation, MM concludes that dividends do not count and that dividend policy has no effect on the share price.
![Page 14: Mm approach of dividend policy](https://reader035.vdocuments.site/reader035/viewer/2022062218/58858cea1a28ab84668b63b3/html5/thumbnails/14.jpg)
Criticisms No perfect Capital Market Existence of Transaction Cost Existence of Floatation Cost Lack of Relevant Information Differential rates of Taxes No fixed investment Policy Investor’s desire to obtain current income
![Page 15: Mm approach of dividend policy](https://reader035.vdocuments.site/reader035/viewer/2022062218/58858cea1a28ab84668b63b3/html5/thumbnails/15.jpg)
Thank You……………..!