Dividend Decision

Dividend Policy
Suggested Readings:
Chapter 11, Van Horne
Cases:
Dividend Policy of Hero Honda
Dividend Policy at FPL Group Inc
FM-II/SD/Dividend Decision
Dividend Policy
 What proportion of earnings is paid to the
shareholders and what proportion is ploughed
back
 Importance
 If capital budgeting is dependent on dividend policy
 Impacts the capital budgeting
 If capital budgeting is independent of dividend policy
 Impacts the choice of financing
Method of rewarding shareholders
 Cash Dividend
 Bonus
 Shares– (Stock Dividend)
 Debentures (HUL)
 Rights at a low price
 Stock Split
 Buy back (Stock Repurchase)
Cash Dividend
 Dividend Rate
 as a % of the face value
 Dividend Per Share
 Face Value x Dividend Rate
 Dividend Pay Out Ratio
 Dividend Paid/ PAT
 Dividend Yield
 DPS / Current Market Price
Relevance
 Is it relevant for wealth maximization
 Relevant
 Dividend Policy has a bearing on the share valuation
 Not relevant
 Value of the firm depends upon its earning powers
and is not influenced by the manner in which these
earnings are distributed
Gordon Model
 P = E (1-b)
k - br
 E = EPS
 b= retention ratio
 r = rate of return on investment
 (1-b) = Dividend Pay-out Ratio
 If r›K – Growth Firm – Optimal payout ratio is Nil
 If r‹K – Declining Firm – Optimal payout ratio is
100%
 If r=K – Normal Firm –Payout ratio is Not relevant
Miller & Modigliani Approach
 Dividend is not relevant
 P0 = 1 (D1+P1)
(1+k)
 nP0 = 1 (nD1+(n+m)P1 – mP1)
(1+k)
 mP1 = I – (E-nD1)
 nP0 = 1 [(n+m)P1 – I + E]
(1+k)
 As dividend is not a variable in the equation, it does not
influence the valuation of the firm
BEL
120.00
100.00
80.00
R s. Per Sh are
60.00
40.00
20.00
0.00
2003 2004 2005 2006 2007 2008 2009
Earning Per Share 32.58 39.51 55.80 72.88 89.86 103.34 93.23
Dividend Pe r Share 7.90 11.29 12.76 16.65 20.94 24.21 21.88
BEL – D P Ratio
30.00
25.00
20.00
15.00
%
10.00
5.00
0.00
2003 2004 2005 2006 2007 2008 2009
Dividend Payout Ratio 24.25 28.57 22.87 22.85 23.30 23.43 23.46
Apollo Tyres
5.00
4.50
4.00
3.50
3.00
2.50
2.00
1. 5 0
1. 0 0
0.50
0.00
2003 2004 2005 2006 2007 2008 2009
EP S 3.30 1. 8 4 1. 7 6 2.04 2.44 4.49 2 . 14
DP S 0.45 0.45 0.45 0.45 0.45 0.52 0.45
Apollo Tyres
30.00
25.00
20.00
15 . 0 0
10 . 0 0
5.00
0.00
2003 2004 2005 2006 2007 2008 2009
Div ide nd P a y o ut Ra t io 13 . 6 1 24.50 25.51 22.07 18 . 4 1 11. 5 0 20.98
Hero Honda
Dividend Rate
1200
1000
800
600
%
400
200
0
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
Year
Pay Out Ratio
Pay out ratio
80
70
60
50
40
%
30
20
10
0
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
Year
Determinants of Dividend Policy
 Target Dividend Payout ratio
 % of net earnings distributed to the shareholders as
dividend
 Optimum D/P ratio that maintains a balance between
current dividends and long term growth prospects
 Funds Requirements
 Liquidity
 Access to External Source of Finance
 Cost of raising finance
 Floatation cost
 Under-pricing
 Earning Stability
 Dilution of Control
Stability of Dividend
 Rationale for stability
 Investors’ Preference
 Institutions Preference
 Lending Institutions
 Credit Rating Agencies
 Informational Contents
 Insiders (Management) is better informed than
outsiders
 Change in dividend implies earning expectations
 Constant D/P ratio
EPS
EPS and DPS
DPS
Time (Years)
 Steadily Changing dividend with target D/P
ratio
EPS
EPS and DPS
DPS
Time (Years)
Legal Requirements
 Contractual Requirements
 Lending Institutions
 Restriction on dividend rate
 Restriction on D/P ratio
 Income Tax Considerations
 Tax rate on capital gains
 Tax rate of dividend
 Dividend distribution tax
Tax on Dividend and Capital Gain
Equity Shares
Period of Holding > 12 Months Period of Holding < 12 Months
Long Tern Capital Gain Short Term Capital Gain
Exempt 15%
• Dividends:
• Tax Free in the hands of shareholders
• Company pays a Dividend Distribution Tax @ 15% +
Surcharge + Cess
Legal Requirements
 Companies Act 1956
 Dividend can be paid out of current year profit or
past profits after providing for depreciation
 Transfer a certain % of profit to reserve depending
upon the dividend rate
 Upto 10% : Nil
 10-12.5% : 2.5%
 12.5%-15% : 5%
 15—20% :7.5%
 Above 20% : 10%
 If past reserve are used for dividend
 Not to exceed average dividend in the last 5 years or
10% whichever is less
Procedural Aspects
 Recommended by the Board of Directors
 Approved by the shareholders in the AGM
 AGM can’t increase the rate recommended by the directors
 Record Date
 To ascertain the eligibility to receive dividend
 Must be paid within 30 days of declaration
 Unpaid dividend
 Within 7 days of the expiry of 30 days to be transferred to
a separate account with a schedule bank
 If not claimed within 7 years transfer the same to
`Investor Education and Protection Fund’
Stock Dividend / Bonus Shares
 Issue of additional shares to the existing
shareholders in proportion to their
existing holding without consideration
 By capitalization of reserves
 Why
 Affordability
 Liquidity in the market
 Informational content
Requirements as per SEBI
Guidelines
 Authorised by its articles of association for issue of
bonus shares, capitalisation of reserves, etc.:
 Provided that if there is no such provision in the
articles of association, the issuer shall pass a
resolution at its general body meeting making
provisions in the articles of associations for
capitalisation of reserve;
 Not defaulted in payment of interest or principal in
respect of fixed deposits or debt securities issued by
it;
 Not defaulted in respect of the payment of statutory
dues of the employees such as contribution to
provident fund, gratuity and bonus;
 Partly paid shares, if any outstanding on the date of
allotment, are made fully paid up
Requirements as per SEBI
Guidelines
 Issue to be made out of free reserves built
out of the genuine profits or securities
premium collected in cash only
 Reserves created by revaluation of fixed
assets not be capitalised for the purpose of
issuing bonus shares.
 Once the decision to make a bonus issue is
announced, the issue can not be withdrawn
Bonus Debenture
 HLL issued Bonus Debenture in the
ratio of 1:1
 Debenture with a face value of Rs.6
 Interest rate – 9%
 Redemption in the 5th and 6th year @
Rs.3 each
Rights
 Issue of additional shares to the existing
shareholders in proportion to their existing
holding for a consideration
 If issued at a very low price compared to the
current market price
 ING Vysa issued rights in the ratio of 3:1 @ Rs.45 in
January 2005
 EPS for the year 2003-04: Rs.26.56
 Book Value Per Share – Rs.238.62
 Industry P/E : 14 Times
 High/ Low for 6 months : Rs.271.05 / Rs.690
Stock Split
 Splitting the existing shares into new
shares of lower face value resulting in
larger number of shares with lower face
value
 Why
 Affordability
 Liquidity in the market
Buy back of shares
 Section 77 A of the Companies Act 1956
 Authorised by the Articles of Association of
Company
 Board Resolution if buy back is less than 10% of
paid up capital and free reserves of the company
 Special Resolution if buy back exceeds 10%
 Buy back in any financial year not to exceed 25% of
the paid up capital
 Ratio of debt not to be more than twice its capital
and free reserves after the buy back
 Extinguish the shares bought back within 7 days
 Not to make further issue within 6 months of
completion of buy back
Why Buy Back
 Why buy-back
 Shares are undervalued
 Company has surplus cash without
investment opportunities
 Buy-back would improve ROI/ROE
 Temporary cash surpluses better utilized for
buy-back than pay dividend
 Tax Considerations
 Control
Learning
 Dividend – relevance
 Determinants of Dividend Policy
 Bonus, Stock Split, Buy Back of
Shares
 Legal, Tax and Procedural Aspects

Dividend Decision

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Dividend Policy

EP S 3.30 1. 8 4 1. 7 6 2.04 2.44 4.49 2 . 14

DP S 0.45 0.45 0.45 0.45 0.45 0.52 0.45

Div ide nd P a y o ut Ra t io 13 . 6 1 24.50 25.51 22.07 18 . 4 1 11. 5 0 20.98

Long Tern Capital Gain Short Term Capital Gain

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