Scribd
Upload
134 views3 pages

Dividend Models

The document discusses various dividend models, including the Modigliani Miller approach, Walter's approach, and Gordon's approach, each providing different perspectives on how dividend policies affect share prices. The Modigliani Miller hypothesis suggests that share prices are determined by earning potential and investment policy rather than income distribution. Walter and Gordon emphasize the relationship between dividend policies and share value, with implications for optimal payout ratios based on the firm's growth status.

Uploaded by

guptadityak20
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
134 views3 pages

Dividend Models

The document discusses various dividend models, including the Modigliani Miller approach, Walter's approach, and Gordon's approach, each providing different perspectives on how dividend policies affect share prices. The Modigliani Miller hypothesis suggests that share prices are determined by earning potential and investment policy rather than income distribution. Walter and Gordon emphasize the relationship between dividend policies and share value, with implications for optimal payout ratios based on the firm's growth status.

Uploaded by

guptadityak20
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd

DIVIDEND MODELS

The various models that support the above-mentioned theories of dividend relevance and
irrelevance are as follows:
Modigliani Miller approach
According to them the price of a share of a firm is determined by its earning potentiality
and investment policy and not by the pattern of income distribution. The model given by
them is as follows: 29
Po = D1 + P1/ (1/Ke)
Where,
Po = Prevailing market price of a share
Ke = Cost of equity capital
D1 = Dividend to be received at the end of period one

P1 = Market price of a share at the end of period one

According to the MM hypothesis, market value of a share before dividend is declared is


equal to the present value of dividends paid plus the market value of the share after
dividend is declared.

29
Dr. S.N. Maheshwari, Elements of Financial Management, Sultan Chand & Sons, New Delhi,
1999, p. C. 74
Walter's approach30
According to Prof. James E. Walter, in the long run, share prices reflect the present value
of future+ dividends. According to him investment policy and dividend policy are inter
related and the choice of a appropriate dividend policy affects the value of an enterprise.
His formula for determination of expected market price of a share is as follows:31
P = D + r/k(E-D)
K
Where, P = Market price of equity share
D = Dividend per share
E = Earnings per share
(E-D) = Retained earnings per share
r = Internal rate of return on investment
k = cost of capital

Gordon's approach32
Dividend Yield Basis
The value of a share, like any other financial asset, is the present value of the future cash
flows associated with ownership. On this view, the value of the share is calculated as the
present value of an infinite stream of dividends.
Myron Gordon's Dividend Growth Model explains how dividend policy of a firm is a basis
of establishing share value. Gordon's model uses the dividend capitalization approach for
stock valuation. The formula used is as follows:
Po = E1 (1-b)
K-br
30
James Walter, " Dividend Policy : its influence on the Value of The Firm", Journal Of Finance,
May 1963, p. 280-290
31
Ravi M Kishore, Dividend Policies and Share Valuation, Taxmann's Financial
32
Prasanna Chandra, "Dividend policy and firm value", Financial Management, Theory and practice,
Fifth edition, Tata McGraw-Hill Publishing Co., New Delhi, p. 479, 480.
Where, Po = price per share at the end of year 0
E1 = earnings per share at the end of year 1
(1-b) = fraction of earnings the firm distributes by way of
dividends
b = fraction of earnings the firm ploughs back
k = rate of return required by shareholders
r = rate of return earned on investments made by the firm
br = growth rate of dividend and earnings
The models, provided by Walter and Gordon lead to the following
implications:
If r > k Price per share increases as dividend payout ratio decreases
If r = k Price per share remains unchanged with changes in dividend
payout ratio
If r < k Price per share increases as dividend payout ratio increases.

This further implies that:

Type of firm Optimum Payout Ratio

For a growth firm Nil

For a normal firm Irrelevant

For a declining firm 100 per cent

Figure: Optimum Payout Ratio

You might also like