FINANCIAL MANAGEMENT COURSEWORK TEST 2 ATUKWASE SYLIVIA REG.NO.

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There exists a contravancy as to whether dividend payment is to any value to the firm. For dividend payment to be valuable to the firm, it should have an effect on the overall valuation of such a firm. If dividend payment doesnt affect the value of the firm, then it is irrelevant. There are two contrasting views regarding the relevance and irrelevance of paying dividends;The Modglian and Miller (M & M) which points out the irrelevancy argument and The traditional / Classical school argument that dividend payment is relevant. There are several theories that argue that dividends are relevant and the dividends policy is very important. Some of the models include; - Walters models and Gordons models and the Classical or traditional school of thought. These theories of relevance argue that if dividends are ignored then the value of the firm will be affected, but according to Modiglian and Miller argument, this is dangerous and therefore the following views according to the classical school of thought show the relevance of dividends; If all earning or profits are paid out as dividends, yet there are viable projects that need financing, a company will be bothered with debt conditionalities. There are some nature of shareholders who require dividends and they will force dividends to be paid and if they are not paid dividends, they can vote out management. The one bird in hand and the two in bush argument. According to this argument the shareholders might prefer a bird in hand to many in bush or in the air. The implication is that there is uncertainty surrounding the future dividends and the gains. Investors therefore see current dividends as preferable since these dividends resolve uncertainty regarding returns on investment. The tax argument. This argument suggests that dividend earnings are taxable and therefore its important to consider the dividend policy. Dividends are taxed twice that is, they are taxed at the company level that is before profits are declared and then again at personal level that is the shareholders dividend income is taxable.

Need for diversification. This argument that investors who want to diversify their portfolio prefer dividends to provide them current income with which to secure investment in their portfolios. Existence of transaction costs. They include charges for floating new shares, brokerage and underwriters costs. These costs actually exist and reduce the value of shares bought and sold on the market. They actually reduce home made dividends. Investors therefore prefer current dividends on which they incur no transaction costs to future capital gains to be realized by sale of shares in the market. Payment of dividends signals good news. According to this argument, payment of dividends provides information to shareholders that the firm is doing well to share while non- payment of dividends conveys the reverse message. Firms which pay dividends will therefore shape the perception of investors positively who will then perceive the firm as less risky than those which dont pay dividends. However, the principal advocates for this position are Modglian and Miller who argued that dividend policy of the firm is irrelevant and doesnt affect the value of the firm. They argue that the value of the firm depends on the firms earnings which results from its investment policy. According to Modglian and Miller, if the Company decides to distribute all profits as dividends, it can secure other sources of financing by issuing more shares for borrowing from financial institutions. If the Company chooses not to pay dividends, the shareholders will not worry because they will make home made dividends. This means that, the shareholders who want dividends but the company has not declared dividends can simply sell off some of its shares to the stock market and make cash. However, Modglian and Miller assume a perfect market, a tax less world and investment policy being given and that there are no risks. Modglian and Millers argument is certainly not realistic because we dont live in a perfect world. There are market imperfections which make the dividend policy relevant. There are two major forms in which dividends may be declared and paid;Cash dividends. Most Companies pay dividends in cash form and for a cash dividend, a Company should have enough cash on its bank account or should prepare to liquidate the

near cash assets. Both the cash and reserve accounts are reduced by the amount of dividend paid and distributed. A cash dividend should only be paid out when;It will not adversely affect the liquidity of the firm. If the firm can secure additional funds after payment of dividends at a reasonable cost. Stock dividends. This involves issuing new shares instead of cash dividends to current shareholders in a proportionate way, such that a shareholder retains his proportionate ownership. If 10% stock dividend is declared, it implies that for each ten shares held, a shareholder will receive one additional share. This will increase the share capital while reducing the reserves. Therefore the total net worth of the firm will remain un changed. The advantages for this that shareholders with a psychological boost to their view of the instrument in the Company. Incase the Company maintains the same cash dividend per share after stock dividend has been given; bonus issue implies additional dividends to shareholders in the future. The use of bonus issue may convey some information that is well since it is associated with growth of Companies. Cash dividends are always taxed highly and therefore the preference is to pay stock dividends which attract lower rates of taxation. However, stock dividends dont increase the net worth of shareholders and from the point of view, bonus issues are more costly to administer than cash advances. The cost of hiring stock brokers and jobbers and supervising those increases. Share splits which involve increasing the number of shares through a proportional reduction in their face value. A stock spilt affects the face value and the number of outstanding shares but the total shareholders funds remain unchanged. In conclusion therefore, to a shareholder dividends payment may look to be more important in business since its one of the ways of performance appraisals.