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Theory of Financial Management

   

Added on  2020-10-04

16 Pages4406 Words26 Views
Financial Management

TABLE OF CONTENTSINTRODUCTION...........................................................................................................................1Part A. Explain Dividend relevance theory and dividend irrelevance theory? ..........................1Benefit to the shareholders of the acquiring company................................................................8CONCLUSION ...............................................................................................................................9REFERENCES..............................................................................................................................11

INTRODUCTIONThis project report is based on financial management , financial management is based onhow to manage the funds in such a manner to achieve the objectives of the organization. This isdirectly related to the top management of an organization, and it is the planning , organising,directing and controlling of the financial activities and from these hows to utilize the funds fromthe resources. In this report we discuss about a dividend and their theories and explain thattheories are relevant and irrelevant with academic research. And also discuss about merger andacquisition fundamental role in business. And evaluate that merger and acquisition willmaximise the shareholder wealth.Part A. Explain Dividend relevance theory and dividend irrelevance theory? Dividend policy which affects the value of firm can be considered as relevant. If there ispositive relationship between a dividend and market value and preference of current dividend isbeen suggested by Walter and Gordon (Linawati and Halim, 2017). Majorly investors are riskaverse and they usually prefer a current dividend which is giving less importance to capital gainand dividends of future. So in this series- Walter Model and Gordon Model Walter Model : James E. Walter says that value of enterprise is always affected by typeof dividend policy. Relationship between cost of capital and internal rate of return plays majorkey role while determining dividend policy which helps in maximizing shareholders wealth(Vogiatzi, 2015). Assumptions of Walter model are,Internal financing has been practised in the context of firm's investments, which areusually with retained earning, external financing is not used i.e. new debt or equity arenot issued for same (Mattli and Dietz, 2014).For all investment decisions business risk remains constant and technically internal rateof return and cost of capital of the firm are same (never change).

Earnings and dividend of the firm in the beginning never change. EPS and DPS are usedin the model but the assumption is that they remain constant while value is beendetermined.Margin or earning which is made by company is reinvested internally or may bedistributed as dividends.The company has long and infinite life (Mellor and Shilling, 2016).Formula for determining market price per share can be denoted as:P=D/K+r(E-D)/K/KP is market price per share, D is dividend per share, E is earning per share, r is internalrate of return and K is cost of capital. This equation gives indication that MPS of firm's share isaggregate of present values of infinite flow of gains from retained earning on investments anddividends.As it is stated above that optimum dividend policy depending on the relationship betweenIRR and Cost of capital. If R is greater than K, entire earnings should be retained and if K isgreater than R then all earnings should be distributed to the shareholders. The main thinkingabout the Walter model when R is greater than K, then organization is able to make more returnas compared to shareholders from retained earnings (Masubuchi 2013). Growth firms have Ksmaller than R. The main assumption is to have enough profitable opportunities. These firms canearn returns very easily which is always more than what shareholders can do on their own.Normal firms have R and K equal. Usually these firms gain same return as compared toshareholders. The price per share is not been influenced by dividend policy, so there is absenceof payout ratio for a normal organization (Baker and Riddick, 2013). Declining firms have lowerR as compared to K, Firm's return is less than compared to shareholder's investment. There is nosense for retaining the earning. So for maximizing the price per share entire earnings should bedistributed among shareholders. Gordon Model: It states that current dividend plays major role in determining firm'svalue. The most famous model for calculating the company's market value by using the dividendpolicy. Assumptions of Gordon model can be,In the capital structure there is no proportion of debt, the company should be form ofequity only i.e. it should be considered as an equity firm (Brigham and Ehrhardt, 2013).2

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