Report on Dividend Relevance Theory and Dividend Irrelevance Theory
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Added on 2020-06-05
Report on Dividend Relevance Theory and Dividend Irrelevance Theory
Added on 2020-06-05
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FINANCIALMANAGEMENT
TABLE OF CONTENTSINTRODUCTION...........................................................................................................................3PART A...........................................................................................................................................3PART C...........................................................................................................................................6Merger and acquisition fundamental role External Growth:......................................................6CONCLUSION..............................................................................................................................11REFERENCES................................................................................................................................1
INTRODUCTIONFinancial management is how to manage the funds and all related money activities whichis prepared, directing and manage and to control on it. Financial management create the wealthfor the business and it also provides the return on investments. And this is used to maximize thecompany wealth and to increase the business productivity. In this report I am discussing aboutwhether the dividend payment is relevant or not in share price of company and also evaluate theboth dividend relevant and irrelevance theories view points. And also discuss the merger andtakeover fundamental role in corporate finance, which affects the external and internal growthopportunities, is possible or not. In this report I am also evaluating that evaluate that merger andacquisition are core financial objective for maximizing the shareholders wealth.PART AExplain dividend relevance theory and dividend irrelevance theory? Dividend means a part of a profit of the company which is given to the companyshareholder. Company need is to provide funds for their long term investment and rather thaninvestors wants to earn more profit on their investments. Dividend policy of the company willaffect the wealth of the share holders and to long term investments. Relevance concept of dividend: If a dividend policy affect the value of the firm is relevant. Thereare two dividend relevance theories of the firm: these are Walter's model and Gordon's model.Walter's model : In a business dividend policy will affect the value of the firm. This model isgiven by James E Walter and they says that dividend policy always affect the value of firm or abusiness. And the company may use this to maximise the wealth of the shareholders. Walter alsogive a mathematical model for proving his point of view (Titman, Keown and Martin, 2017).This model is based on relationship between return on investment of the firm and firm cost ofcapital.Assumption which is related to the Walter's model these are:The firm sourced their finances by retained earnings. The firm does not use the externalsources of funds like debt or new equity capital.In the starting of a business earning per share and dividend per share should be constant.In the determining of the results that vale of earning per share (E),and value of dividend(D) it will be changed
The firm has a very long life.The firms earnings are distributed as dividends or reinvested internally.The firm business risk not change after the additional investment is done. So it impliesthat firm internal rate(r) and cost of capital(k) remains constant.For determining the market value of a share Walter's suggest the formula:P=D/K=r(E-D)/K/KIn this P is a market price of an equity share, D is a dividend per share, r is the internal rate ofreturn, E is earning per share And K is cost of equity capital rate. According to this theory , thedividend policy mainly depends on the relationship between the firms internal rate of return andcost of capital. If R is greater than K the firm should be retain their earnings and and If R is lessthan K then the firm distributed the earnings to their shareholders . In case of when R is greaterthan K so the firm is able to earn more return from retained earning. It already clear that themarket price per share is the present value of an infinite stream of constant dividends and thepresent value of the infinite stream of profits (Bekaert and Hodrick, 2017). In the firm using themodel firm can growth there are several investment opportunities where r is greater than K andthe firm can reinvest earnings at a higher rate r thus they will maximize value per share if theyreinvest all earnings. If the firm normally increases there growth so there is not investmentavailable for the firm that are earn higher rates of return thus the dividend policy has no effect onmarket price. Declining firm are not having profitable investment for the firm to reinvest itsearnings . In this the firm pay out its earnings as a dividend to their share holders.Gordon's model:This model is related to the market value of the firm and this model is given byMyron Gordon. According to Gorden dividend per share is to grow when earnings are retained.In this model dividend per share is equal to the payout ratio and its multiplied by earnings (Priyaand Mohanasundari, 2016). In this to determine the value of the firm therefore based on thedividend growth.Assumption of Gordon's model are:In this no external financing is available the firm is an all equity firmThe internal rate of return(r) of the firm is constantThe discount rate (K) of the firm remain constant
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