DIVIDEND DECISION MODELS
(WALTER, MYRON GORDON,AND MM MODEL)
WALTER'S MODEL OF DIVIDEND POLICY
WALTER'S MODEL says that dividend policy and value of firm is directly related. Dividend policy affects the market price of the share and the relevance of dividend policy for valuation of the firm.
Walter's model of the firm is based on the following assumptions:-
ASSUMPTION OF WALTER'S MODEL:
1. All investment proposals of the firm are to be financed through retained earning only and no exter- -rnal financing is available to the firm.
2.The business-risk complexion of the firm remains same even after fresh investment decision are taken. In other words, the rate of return on investment i.e..."r" and the cost of capital of the firm i.e.....Ke are constant.
3. The firm has infinite life.
This model state that firm's dividend decision is based on the principle that if a firm has investment opportunities available to invest the retained earning. If a firm has suitable investment opportunities available than the firm will consider to invest rather than to distribute dividend.
This model can be summarised as follows:-
A firm can maximise market value of its shares and firms value by following the below approach-
1.if r>Ke, the payout ratio should be zero ( retention of 100%)
2.If r<ke, the payout ratio should be 100% and the firm should not retain any profit and
3.if r=ke, the dividend is irrelevent and the dividend policy is not expected to affect the market value of the share.
P = D/ke + {r*(E-D)/ke}/ke, where,
P=market price of share.
D=dividend per share paid by the firm.
Ke=Cost of equity share capital
E= Earning per share of the firm.
MYRON GORDON'S DIVIDEND POLICY
MYRON GORDON had similar view as Walter dividend policy .He suggest that the dividend policy is relevant for the value of the firm.
ASSUMPTION OF MYRON's MODEL OF DIVIDEND POLICY
1. All the investment project should be financed through retained earning only and no external finance is available t the firm.
2.The business risk complexion of the firm remains same even after fresh investment decision are taken. In other words, the rate of return on investment ie..'r' and cost of capital of the firm i.e....ke are constant.
3 The firm has an infinite life.
4.The cost of capital beside being constant is more than the growth rate i.e.. ke>g.
Myron Gordon profounded that investor are risk averse and they prefer present current dividen as compared to future uncertain gain in the form of capitlal gains and future dividend.Gorden model is based on the " A bird-in-the-hand- is- better -than- two- in -the- bush".With the help of Gorden model market price of share can be calculated as follows:-
P=E(1-B)/(Ke-Br)
P=market price of equity share
E=earning per share of the firm.
Br=retention ratio
ke=cost of capital
Br=g=growth rate of firm
MM MODEL OF DIVIDEND POLICY
MM model of dividend policy has a different say regarding dividend policy and value of firm.MM argue that dividend policy has no effect on the value of firm.Dividend policy is irreverent with regard to firms value.The shareholder of a firm does give importance to present dividends or future capital gains.Firms that pay more give less price appreciation but provide same total return to shareholders.
MM model is based on the following assumption.
ASSUMPTION OF MM MODEL OF DIVIDEND POLICY:-
1. The capital markets are perfect.
2 Complete information is available to all the investors.
3. Information is available free of cost.
4.The securities are indefinitely divisible.
5.Investors are rational and well informed about the risk return of all securities.
6.Companies do not incur any flotation cost
7.Perfect market also employ that no single investor can affect the market price of a share
8.There is no corporate income tax.
9.Ke remains constant.
10.The organisation has fixed investment policy.
Po=Market price of shares
D=Dividend per share
P1=market price of equity shares at the end of year 1
Ke=cost of cappital
MM argues that a firm paying dividends will raise funds externally to finance its investments.
When dividends are paid value of shares decline. However there are no changes in total wealth of shareholders.because dividend plus price of share comes t the same.
CRITICISM OF MM MODEL:-
1. capial Markets are imperfect.
2.presence of tax system
3.Presence of floatation cost
4.Code for obtaining information.
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