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(PDF) Optimization of investment portfolio management

   

Added on  2021-04-24

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RUNNING HEAD: FINANCE PORTFOLIO MANAGEMENT Financial management

Finance portfolio management 2Question 1 Dividends are basically the amount, companies paid to their shareholders from their earnings.The amount paid can be in the form of cash, shares or other property. Companies can declare dividends over different time periods and at different pay out rates (Baker, 2009). However, some of the organizations does not prefer to distribute some part of their earnings as dividends to their shareholders. In fact, they are more suitable with reinvesting their earnings back into the company. Generally, the companies which are profitable and have stable earnings, pay dividends because they do not need to reinvest their income in the business for the purpose of growth. Moreover, investors are more likely to purchase that company’s stock which offers them stable income in form of dividends. Payments regarding dividends reflect the financial strength of the organization and is considered as a sign that the company will make profits in future, which eventually makes its stock more attractive. So for such mature and stable companies, dividend payments do matter (Clayman, Fridson and Troughton, 2012).In contrast to it, firms enjoying rapid growth choose to reinvest their profits or earnings in the business rather than distributing them to the shareholders as dividends. The reason behind doing this is to stimulate the future growth, to increase the value of share price by investing the funds in a new project, acquiring new assets, purchasing their own shares or buying another company. Moreover, the decision of not paying dividends may prove to be very beneficial for the investors from the aspect of paying tax. Reason being, dividend is treated asan income of the shareholders and investors and they are obliged to pay tax on them at a certain rate. So, for the companies who are willing to grow rapidly and want to avoid the risk associated with lack of capital, dividends do not matter as they put all the earnings back in thebusiness (Forbes India. 2012).

Finance portfolio management 3However, there are many theories which sated the relevancy and irrelevancy of dividends. Generally, payments related to dividends are view positively by the investors and firms as it reduces the risk of uncertainty in the shareholders and increases the value of company’s stock. The two theories which support the relevance of dividends are given by Walter and Gordon. Professor James E Walter stated in his theory that it is the dividend pay-out ratio which always affect the value of firm (Bose, 2011). In addition to this, he also mentioned the importance of relationship between internal rate of return (R) and cost of capital (K) for the purpose of determining optimum dividend policy. Based on the certain assumptions, his theory concludes that if R>K, then the company should invest its retained earnings rather than using them for declaring dividends. Reasons being, investment opportunities will provide better returns than dividend payments. However, if R<K, then the firm should distributes its earnings among its shareholders as dividends rather than investing them somewhere else. Thus, it can be said that it is the relationship between R and K which decides, whether the company should have 100% pay-out or zero pay-out (Periasamy, 2009).In support of the above theory, a model was introduced by Myron J. Gordon, who also supported the relevancy of dividends. It is known as Gordon’s Model which believes in the fact that regular dividends affect the company’s share price. However, the assumptions and the findings of Gordon’s model were similar to Walter’s model but later Gordon revised its theory and takes into account the two factors named as risk and uncertainty (Pandey, 2015). Itstated that investors are risk averse and the payment of future dividend is totally uncertain. This makes the investors to prefer current dividend over the future ones. Being a rational investor, they are ready to quote higher price for the shares on which current dividends are paid by the company. Hence, the discount rate (K) increases as and when the retention rate rises. So, on a whole it can be concluded that for some companies having an appropriate

Finance portfolio management 4policy is very important, as it affects the market value of the firm (eFinanceManagement.com. n.d.).Apart from the relevancy theories, there are some approaches which contradict the above theory and lay emphasis on the irrelevancy of the dividends. A Modigliani-Miller model is one of them which states that dividend policy of an organization is irrelevant. According to the theory given by MM, the value of a firm wholly depends upon its potential to earn more from its investment policies. The theory is based on certain assumptions and the findings shows that if the company invest the retained earnings in the business rather than distributing it as dividends, the shareholders could enjoy capital appreciation (Banerjee, 2012). The theory said that from shareholder’s point of view, it is totally irrelevant to divide the income between dividends and retained earnings. Reason being, if company distribute dividends, thenthe amount of dividend will be equal to the figure by which the capital could be appreciated. Hence, there is no relevancy and the market value of the firm is also not affected (Cassis, Grossman and Schenk 2016).From the above debate it can be said that, dividends does and does not matter for the companies depending upon their earnings, profitability and objectives. Question 2A comparative analysis of Melrose Industries PLC and Balfour Beatty is done in order to decide which company is better for the purpose of making investment. Profitability, gearing and investors’ ratios are calculated to measure the financial performance and position of the companies. Working capital is also taken into consideration.Working capital

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