Dividend Relevance and Irrelevance Theory for Mergers and Acquisitions

Financial Management

TABLE OF CONTENTS
INTRODUCTION 1
Part A Dividend relevance and dividend irrelevance theory 1
Part C Explaining mergers and acquisitions, how they are financed and relevant parties involved
in the process 5
Conclusion 8
REFERENCES 9

INTRODUCTION
Financial management refers to planning, organizing, directing and controlling all the
financial activities for procurement of enterprise. With the help of financial management there is
optimum use and allocation of resources for improving operational efficiency of the
organization. It helps in managing sound financial decision of the concern of organisation. In this
report there is a brief understanding of strategic decisions should organizations have to apply.
And how these decisions helps in accounting and finance of the organization. In part A Dividend
relevance theory of Walter and Gordon, Modigliani Miller theory of irrelevance dividend theory
is been explained. In next part importance of merger and acquistions, major parties involved is
elaborated.
Part A Dividend relevance and dividend irrelevance theory
Dividend Relevance theory indicates that company's dividend policy is not a concern for
investors because they have option for selling proportion of equity's portfolio if there is need of
liquidity.
 Walter's model
 Gordon model
Walter model: This model is given by prof. James E. Walter, the firm's share price is
been affected by dividends and policy of investment cannot be separated by policy of dividend as
there is a relationship between them. This model clearly depicts the relationship between the
internal rate of return (r) or return on investments and cost of capital (K). The selection of
dividend policy majorly affects the overall firm's value(Zietlow, and.et.al., 2018). The
relationship between returns and cost shows the efficiency of dividend policy. Walter's dividend
policy can be denoted as:
P = D/k +{r*(E-D)/k}/k
In the above formula P is denoted as market price per share, D represents dividend per
share, E represents earning per share, r represents internal rate of return of firm and k is denoted
as cost of capital of the organization. In short this equation gives an idea that market price of the
company's share is the aggregate of present values of infinite flow of gains on investment from
retained margin and flow of dividends.
If K is smaller than r, earnings should be retained by the company as it possesses the best
opportunities for investment and can get more advantage as compared to shareholders by
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reinvesting. The company which are giving more returns as compare to cost are indicated as
“Growth firms” and there payout ratio is zero. In second case, if r is smaller than K, then all the
earnings should be paid to shareholders in dividend form because all shareholders have better
opportunities for investment than a firm. The payout ratio for the mentioned case is 100%. in last
scenario, where r is equals to K, then there is no effect on value of the company. The firm is
indifferent that how much amount should be retained and to distributed among the shareholders
and for the same the payout ratio is in the range of zero to a hundred percent.
The assumptions related to this model are:
 External financing is not used for the company all funding is done via retained earnings.
 If there is any change in investments but (r) rate of return and (k) cost of capital remains
same.
 All the earnings or margins are distributed among shareholders or they are retained.
 DPS or dividend per share and EPS earning per share remains same.
 Perpetual life of the organization(Titman, Keown, and Martin, 2017).
Criticism of this model:
 If external financing is not used then standard will be low of either dividend policy or
investment policy or both.
 Its applicability is to only equity firms, along with this rate of return is constant so
investments are decreased.
 In real scenario, K cannot be same, in this business risk is avoided which has direct
impact on value of the organization.
Therefore, Cost of Capital (K) is equals to Cost of equity (Ke), because of absence of
external source of funding is used.
Gordon model: This model is given by Myron Gordon who says that dividends are
relevant for the share prices of the organization. The main assumption taken by Gordon that all
investors are risk averse that means no one is willing to take risks and certain returns are being
preferred as compared to uncertain returns(Skogrand and.et.al., 2011). For avoiding risk, current
dividends are preferred and because of risk there are chances for not getting returns on the
investments which are done. But if the earnings are being retained by the company then there are
chances for getting dividends in the future. The future dividends are not certain even time and
amount is also not certain like when and how much the dividends will be received. Future
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