Analysis of Dividend Policy Assignment 2022

Running head: ANALYSIS OF DIVIDEND POLICY
ANALYSIS OF DIVIDEND POLICY
Name of Student
Name of University
Author’s Note

1ANALYSIS OF DIVIDEND POLICY
INTRODUCTION:
The dividend irrelevance theory can be termed as the theory where the investors do not
consider the company’s dividend policy rather they sell the stocks or the portion of the portfolio
of equities. This enables them to have liquid cash. The dividend irrelevance theory also states
that the declaration of the company’s dividend theory does not affect the investors who are the
owner of the stock of that company. As per this theory the company the dividend does not add
any value to the company’s stock price.

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DIFFERENT TYPES OF DIVIDEND:
The problems that are associated with the company’s dividend policies can make any
financial professional in the state of dilemma and uneasy. The dividend paying policy of any
company affects the company’s retained earnings, growth opportunities, company’s overall
values and even the shareholder’s wealth. As per Kent (2014), the dividend policies of the
company needs to be created in such a way that the company can generate revenue from the
market and also the profit maximization of the company can be increased by considerable means.
Kent (2014) also suggested that the dividend policy of the company is one of the most important
part of the corporate financial management for the company. The dividend policy of the
company should state that the amount of cash a company should reinvest in the business. The
reinvestment can be done to assist the business to expand or to buyback more share from the
market. The dividend policy of the company also decides the amount of cash the company to
provide to its shareholders in the next financial year or accounting year. The dividend payment
made by the company to its shareholders or the owners of their shares must be out of its
earnings. The dividend paid by the company is mostly in the form of cash. The payment of the
dividend made by the company to its shareholders gave rise to the different policies that might
affect the company’s financial position. The three most used dividend policy model that are used
by the companies are as follows:
Modigliani-Miller Hypothesis Model:
Modigliani Miller Model is the model that states about the irrelevance concept of the dividend
paid by the company to its shareholders. As per this model the market value of the company can be
calculated using the earning power of the company and also the risk that are associated with the
underlying asset of the company that is independent of the finances investment or any kind of distributes

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investment (Yuan et al 2014). As per this method the firm can choose for three ways to finance. The
three finance includes borrowing, spending of the profits and insurance of shares. Modigliani and Miller
also stated that after assuming certain things the company will find no difference between the debt or
equity. Modigliani and Miller theorem firstly assumes that the market is the perfectly efficient. As per
this theorem it can be stated that the company operating in the perfectly efficient market do not pay any
kind of taxes, trading of the securities are also been exceeded, and other information are perfectly
symmetrical. As per this proposition the unlevered firm is equal to value of levered firm. Here,
unlevered firm can be explained as financing made through equity and value of levered firm can be
termed as financing through mix of debt and equity. When the company is doing business in perfectly
efficient market then the capital structure of the company does not impact its value. The only
disadvantage that can be drawn from the first proposition of Modigliani Miller is that the company need
to pay taxes in the perfectly efficient market, so the company do not have a chance to enjoy tax-
deductible interest payment.
As per the proposition made by Modigliani Miller theorem the cost of equity of the company is
directly proportional to the leverage level of the company. To compensate the risk that are associated
with the additional risk are higher than the cost of equity.
As per the analysis of the two propositions of Modigliani Miller Theorem, it can be determined
that the second propositions are real to the world and company can actually invest in debt and equity,
which will be similar to the leverage level of the company. In this proposition also the company needs to
consider the tax rate and debt of the company. This will also assists the company to generate revenue as
the tax deductible interest payments.

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Modigliani Miller model also assumes that investors behave rationally. This means that the
investors have only interest to maximize the wealth by any means (Genheden, Ryde and Söderhjelm
2015). If the situation arises where an individual investor wants to increase the cash then it will not
depend on the dividend of the shares rather they will opt for selling the shares that will provide them
readily available cash from the market.
Walter’s Model:
Walter’s model was first suggested by James E. Walter. As per this model that the
dividend policy and investment policy are not different rather it is interlinked. This can affects
the value of the firm. As per this model it can be understood that the company has the
relationship between the firms’ internal rate of return and the cost of capital of the company.
Walter has stated the internal rate of return as r and cost of capital stated as ‘k’. Thus, the
relationship between the r and k determines the dividend policy of the company (Carayannis,
Sindakis and Walter 2015). As per Walter the retain earnings of the company should remain
intact if the investment of the firm exceeds the cost of capital of the company. The opposite may
also occur when the retain earnings are being distributed among the shareholders. Walter has
also proposed two propositions.
As per Walter the firm can be termed as growth firm when the internal rate of return is
greater than cost of capital of the company. This implies that the company has profitable
investment opportunities. In case of this growth firms the optimum dividend policy can be
termed as the D/P ratio. The D/P ratio of the firm can be termed as 0 when the firm is stated as
growth firm. In case of the growth firms the retain earnings of the company states as itself and as
such the market value of the company will be maximized by considerable means.

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Walter has also proposed another proposition where the internal rate of return is less than
cost of capital of the company. In this case the firm can be stated as the declining firm. The
declining firm indicates that the firm has fewer opportunities to invest in their earnings. The
retention of the profit is not profitable for the firm. In this case the retention is not at all
profitable.
If the company seen a 100% D/P ratio then the company can can maximized its earnings
by the payment of the entire earnings to the shareholders of the company. If the investors get
better earnings in terms of dividends then the company can earn higher rate of return by
investments such amounts.
As per the third proposition that is proposed by Walter, the internal rate of return will be
equal to the cost of capital when the market price of the company will be constant (Choi et al
2016). This occurs when the company does not invest in any profitable projects then the rate of
return for the company will be equal to the cost of Capital of the company.
Walter model is based on several assumptions. This assumptions can be stated as all the
financing activities that are done by the company is through the firms. This means that the company will
depend on the external sources of funds, debt or new equity capital. The model also assumes that both
internal rate of return and cost of capital are to be remained as constant. Walter also assumes that the
main variables like opening earnings per share and dividend per share. It also assumes that all the
investment made by the company in a financial year are reinvested internally or distributed by the way
of dividends. Walter also assumes that the company has perpetual existence or very long life span.
Walter model has very vivid use in the reality. This means that the assumptions of constant
internal rate of return and cost of capital do not happen in real life. The market will also remain constant,

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which is one of the problematic part. In real world the change in internal rate of return and the cost of
capital is very common and the change in the market price is also very common. In real world Walter
model will be less effective.
Gordon’s Model:
Myron Gordon has developed a theory regarding the dividend policy of the company.
Gordon states the relationship between the internal rate of return and cost of capital of te
company. As per Myron Gordon the dividend policy mainly depends on the profitable
investment opportunities. Gordon has also proposed three propositions.
As per Gordon, a company can be termed as the growth firms when the company’s share
value increases than the retention ratio of the company (Hairer and Shen 2016). The vice-versa is
alo possible when the firm is growth firm. As per this concept the company can distribute the
smaller dividends and the retain the high earnings.
On the other hand, the company can be stated as declining firms when the share value of
the company decreases and the retention ratio of the company decrease by considerable means.
In this scenario the company can become loss making company and failed to realize profit from
the market.
Gordon also proposes another proposition where the value of the firm does not affect the
dividend policy of the company. It occurs when the internal rate of the company is equal to the
cost of capital of the company. Gordon also mentioned that when the internal rate of return of the
company is equal to cost of capital of the company then it becomes irrelevant for the company.

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To perform the proposition by Gordon in Gordon’s model, some factors are assumed.
Gordon assumed that investors are stated as risk adverse and premium is taken in case of the
certain return and discount is taken as uncertain return.
Among all the model Gordon’s model and Modigliani Miller model are stated to correct
where the dividend irrelevance theory sits well (Kormos and Zaránd 2016). These theories state
that the company’s financial position and investment decisions greatly mold the company’s
investment decisions. These theories also states that the dividend irrelevance theory may be
present in the market and can affects the company’s dividend policies.
Dividend Irrelevance Theory:
The dividend irrelevance theory states that the company’s declaration and payment of
dividend has very minute impact on the stock price of the company. According to this theory the
value of the dividend or specifically speaking the payment of the dividend does not add value to
the company share price. The company share price will unalter if the company does not provide
any kind of dividend price. On the other hand the other different studies states that the payment
made by the company to its shareholders has great impact on the share price of the company. It is
also evident that the dividend coming from blue chip stocks provide enough money and the
investors depend on such dividends (Priya and Mohanasundari 2016). If the dividend is not paid
after some time then it is seen that the company’s share price decrease by considerable means.
The company can see a considerable fall in the share price. It is also believed that the company’s
financial healrth can be displayed by the amount of the dividend paid by the company. If suppose
the company is paying a less amount in terms of dividend then the company can face less
investment, which led to drop in the share price in the market. The fewer dividends produces an
idea among the investors that the company is not doing well in the market and may face some

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serious problem in future. These made the investors sale their shares and gradually the share
price of the company decreases by considerable amount.
Dividend irrelevance Theory suggests that the company’s financial position depends on
the company’s dividends that also depend on the portfolios of the management of the company.
It is also seen many investors looks after the dividends while managing their portfolios. If the
investor observes that the company pays fewer amounts then the investor’s agreed to get current
income strategies (Baker and Weigand 2015). The investors will able to avoid risks that are
bearded by the investors while owning the shares of the company. As per the dividend irrelevant
theory the strategies that are mostly inclined towards the income are always the favorite for the
investors. The investors are always in search for the portfolio that will provide enough stability
that will provide them maximum return and has to bear minimum risk. The investor who wants
to take fewer risk are always go for taking less risk by investing in blue chip stock where the
dividend is more important (Nishihara and Shibata 2017). The dividend is one of the most
dependable factors for this kind of investment. In this case the dividend irrelevance theory is one
of the major back draw. Thus, the dividend irrelevance theory of the company is not always right
and in most cases it becomes irrelevant.
The MM model, Walter Model and Gordon’s Model stated that the dividend irrelevance
theory may be possible in certain situations but it is not relevant in every situation. The situation
where the investor is trying to invest for a long-term period and tries to enjoy the dividend for a
prolong period of time then the irrelevance theory gets null void. On the other hand, if the
investor tries to speculate then they will follow the dividend irrelvance theory and they will not
focus on the dividend paid by the company (Weining 2017).

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SUMMARY:
As per the above discussion it can be concluded that dividend irrelevance theory is
sometimes irrelevant if it is compare to the real life situations as sometimes the investors behave
in a very good manner. The investors of the company mostly do not follow the dividend
irrelevant theory. The other theory that is proposed by the Modigliani Miller, Walter and Gordon
does not present any evidence that is related with the real world factor. The company’s financial
position and the behavior of the investors cannot be determined by any kind of theory because it
changes depending on other factors that may be internal or external factors. The internal factors
maybe profit maximization ability of the company, corporate governance of the company and
other factors. The external factors may include political factors of the country in which the
company is working in, the economic factors, the environmental factors and many more. Thus,
the decision of the investors of not thinking of any dividend just because they can sell the shares
totally depends on the individual and not any market condition.

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REFERENCING:
Baker, H.K. and Weigand, R., 2015. Corporate dividend policy revisited. Managerial
Finance, 41(2), pp.126-144.
Priya, P.V. and Mohanasundari, M., 2016. Dividend policy and its impact on firm value: A
review of theories and empirical evidence. Journal of Management Sciences and
Technology, 3(3), pp.5969.
Yuan, J., Liu, A., Ma, X., Liu, X., Qin, X. and Zhang, J., 2014. The ${\schmi g} $-Good-
Neighbor Conditional Diagnosability of ${\schmi k} $-Ary ${\schmi n} $-Cubes under the PMC
Modeland MM* Model. IEEE Transactions on Parallel and Distributed Systems, 26(4),
pp.1165-1177.
Genheden, S., Ryde, U. and Söderhjelm, P., 2015. Binding affinities by alchemical perturbation
using QM/MM with a large QM system and polarizable MM model. Journal of computational
chemistry, 36(28), pp.2114-2124.
Carayannis, E.G., Sindakis, S. and Walter, C., 2015. Business model innovation as lever of
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Mathematical Physics, 341(3), pp.933-989.

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Kormos, M. and Zaránd, G., 2016. Quantum quenches in the sine-Gordon model: a semiclassical
approach. Physical Review E, 93(6), p.062101.
Nishihara, M. and Shibata, T., 2017. Default and liquidation timing under asymmetric
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