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Definition of Dividend Capitalization Model

The dividend capitalization model is a method for estimating a firm's cost of equity capital. It approximates future dividends based on history and growth rates, and equates the dividend stream to the current market price. Dividend recapitalization occurs when a private equity firm issues new debt to pay a special dividend to investors, reducing risk but increasing debt. Key aspects of dividends include that companies have no legal obligation to pay them, they are a share of profits, and yield is a better indicator of dividend strength than percentage.

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71 views4 pages

Definition of Dividend Capitalization Model

The dividend capitalization model is a method for estimating a firm's cost of equity capital. It approximates future dividends based on history and growth rates, and equates the dividend stream to the current market price. Dividend recapitalization occurs when a private equity firm issues new debt to pay a special dividend to investors, reducing risk but increasing debt. Key aspects of dividends include that companies have no legal obligation to pay them, they are a share of profits, and yield is a better indicator of dividend strength than percentage.

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nuk.2021018028
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We take content rights seriously. If you suspect this is your content, claim it here.
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Definition of Dividend Capitalization Model

Method for estimating a firm's cost of common (ordinary) equity. This


approach approximates a future dividend stream based on the firm's
dividend history and an assumed growth rate, and computes the market
capitalization rate that equates it with the current market price. In the case
of closely-held firms (such as sole proprietorships and partnerships) which
do usually not distribute profits as dividends, the firms dividend paying
capacity is estimated from its average net income and average cash flow and
compared with the dividends actually paid by a similar size firm. Also called
dividend growth model.

Current Share Price

The share price of a company can be found by searching the ticker or


company name on the exchange that the stock is being traded on, or by
simply using a credible search engine.

Dividend Growth Rate

The Dividend Growth Rate can be obtained by calculating the growth (each
year) of the company’s past dividends and then taking the average of the
values.

The growth rate for each year can be found by using the following equation:
Assumptions of this model:

 The firm is an all equity firm. No external financing is used and


investment programmes are financed exclusively by retained
earnings.
 Return on investment( r ) and Cost of equity(Ke) are constant.
 The firm has perpetual life.
 The retention ratio, once decided upon, is constant. Thus, the
growth rate, (g = br) is also constant.
 Ke > br

What is dividend recapitalization?

 Dividend recapitalization is when a private equity firm issues new


debt so as to raise money to pay a special dividend to the investors
who helped fund the initial purchase of the portfolio company.
 The dividend reduces the risk for the PE firm by providing early and
immediate returns to shareholders but increases debt on the
portfolio company's balance sheet.
 A dividend recapitalization is often undertaken as a way to free up
money for the PE firm to give back to its investors, without
necessitating an IPO, which might be risky.
 A dividend recapitalization is an infrequent occurrence, and
different from a company declaring regular dividends, derived from
earnings.

What is mean by dividend in stock market?

Main important points pertinent to dividends in stocks:-

1. There is absolutely no legal obligation for any company to pay any


dividends to its shareholders.

2. Dividends are basically the part of profit or "cash in hand" which a


company shares with its shareholders.

3. Percentage of dividend paid by any company is, in no way, any indication


of the quality of the company. Just from dividend yield we can’t say whether
a company is good or bad.

4. All dividend income are tax free for the shareholders while it is taxable for
the companies, which is called dividend distribution tax. This is to desist the
promoters to take away all the company assets and profits from company to
their own accounts.

5. Dividend values are calculated as dividend percentage of "face value" and


not market value. For example, 250% dividend declared by Infosys means
for each share of infosys with market value of 970 Rs, you will get just Rs.
2.5 of dividend as its face value is merely Re. 1 only.

6. Correct way to measure dividend is by the parameter called dividend


yield. Any stock giving more than 0.5 dividend yield may be considered as
good paying dividend stock.

7. The stock price of the company giving dividend gets reduced by exactly
the same dividend amount on the record date ie the date when the dividend
is actually provided. Hence, it does not have any material impact on your
overall finance due to dividends.

8. You must have the stock in your dmat account on the record date to be
eligible for dividends. As it takes T+2 days normally to get the stock
delivered in your dmat account after purchasing it, you should buy the
same at least two days before the record date to be sure of getting the same.

9. Dividends can be provided monthly, quarterly, half yearly, yearly or at


any time the company finds it deemed fit to do the same. Main reason they
provide the dividend is that they are not finding better alternatives to use
the cash for expanding their businesses and to maintain better shareholder
loyalty or under the pressure of major shareholders or promoters etc.

10. Most Govt PSUs, Cash Flush IT companies and Small cap companies
provide max dividends as govt needs cash to balance its fiscal deficit while
promoters in small cap companies hold max stocks and want to take
benefits from the company. Dividends make companies financially weaker
while increasing the wealth of shareholders.

11. Due to dividends, the cost of shares get reduced by the same amount
and hence becomes more attractive to buyers across a period of time.

12. Example of good dividend paying companies are coal india, hindustan
zinc, SBI, PFC, REC, ONGC, BPCL, HPCL, IOC, Infosys, Wipro, Tcs etc.

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