1. CHAPTER NO. 9 DIVIDEND POLICY & DECISION BONUS ISSUE RIGHTS ISSUE

2. INTRODUCTION TO DIVIDEND POLICY
The term dividend refers to that part of profits of a company which is distributed by the company among its shareholders . it is the reward of the shareholders for investment made by them in the shares of the company Dividend is a right of shareholders to participate in the profits and surplus of the company for their investment in the share capital of the company ,SO, they should receive fair amount of profits.

3. Impact of Dividend decision A company needs to provide finance its long term growth. If a company pays out as dividend most of what it earns, then for business requirements and further expansion it will have to depend upon outside resources such as issue of debenture Or new shares Dividend policy of the firm has its impact both on long term financing and shareholders wealth as well as on the valuation of firm.

4. DIVIDEND DECISION AND VALUATION FIRMS
The value of the firm can be maximized if shareholders wealth is maximized. There are conflicting views regarding the impact of dividend decision on The valuation of the firm According to one school of thought, dividend decision does not affect the shareholders’ wealth hence the valuation of the firm. According to other school of thought, dividend decision materially affects the shareholders’ wealth and also the valuation if the firm. The views of the two schools of thoughts are divided in to two groups are as follows 1. The Irrelevance concept of dividend(one school of thought) 2. The Relevance concept of dividend (other school of thought)

5. THE THEORY OF IRRELEVANCE THE THEORY OF RELEVANCE
DIVIDEND DECISION AND VALUATION FIRMS
THE THEORY OF IRRELEVANCE
A. RESIDUAL APPROACH
B. MODIGLIANI & MILLER APPROACH
THE THEORY OF RELEVANCE
A. WALTER’S APPROACH
B. GORDON’S
APPROACH

6. THE THEORY OF IRRELEVANCE
1. RESIDUAL APPROACH
According to this theory, dividend decision has no effect on the wealth of the shareholders or the price of the shares and irrelevant so far as the valuation of the firm.
This theory regards dividend decision merely as a part of financing decision because the earnings available may be retained in the business for reinvestment.
If the funds are not required in the business they may be distributed as dividends.
The decision to pay dividends or retain the earnings may be taken as a residual decision.
Assumptions
No difference between dividends and retentions for the investors
Investors desire is to earn higher rate of return

7. THE THEORY OF IRRELEVANCE
2. MODIGLIANI & MILLER APPROACH
According to MM Model dividend policy has no effects on the market price of the shares and the value of the firm determined by the earning capacity of the firm or by its investment policy.
The splitting of earnings between retentions and dividends does not affect the value of the firm.
ASSUMPTIONS
Perfect capital markets
Investors behave rationally
Information about company is available to all without any cost
No flotation & transaction cost
No investors is large enough to effect the market price of the shares
No tax application on dividend and capital gains
Firm has rigid investment policy

8. THE ARGUMENT OF MM MODEL
The argument given by mm in support of their hypothesis is that whatever increase in the value of the firm result from the payment of dividend, will be exactly off set by the decline in the market price of shares because of external financing & there will be no change in the total wealth of the shareholders. MM Model gives 3 formulas by which we can calculate market price of the shares, no. of shares to be issued and valuation of the firm

9. Formula’s by MM Model TO CALCULATE MARKET PRICE
TO CALCULATE NO.S OF SHARES TO BE ISSUED
TO CALCULATE VALUE OF THE FIRM
Mp of a share in the beginning of a period is equal to the present value of dividends paid at the end plus mp of shares at the end of the period
It explain that investment required by the firm on account of payment of dividends is financed out of new issue of equity shares.
It also ascertained the value of the firm
Po= market price per share in beginning, D1= dividend received at end, P1= mp at end, Ke = cost of equity
m= number of shares to be issued, I= Investment required, E= total earning, P1= mp at the end, n= no.s of shares outstanding
nPo= value of the firm

10. CRITICISM OF MM APPROACH
Perfect capital market does not exist in reality
Information of company is not available tom all persons
Firm have to incur flotation cost
Taxes do exist
The firm do not follow rigid investment policy
Investors have to pay fees, brokerage
Shareholders may prefer current incomes as compared to further gains

11. THE THEORY OF RELEVANCE
1. WALTER’S APPROACH
Prof. Walter’s approach supports the doctrine that dividend decisions are relevant and affect the value of the firm.
The relationship between the internal rate of return earned by the firm and its cost of capital is very significant in determining the dividend policy to sub serve the ultimate goal of maximizing the wealth of the shareholders.

12. Implications of Walter’s approach
comparison
result
1. r > k
If the firm earns a higher rate of return on its investment than required rate of return, the firm should retain the earnings. Such firms termed as growth firms.
2. r < k
If the firm earns a lesser rate of return on its investment than required rate of return, the firm should distribute the earnings with 100% pay out ratio known as optimum payout ratio.
3. r = k
If the firm earns a equal rate of return on its investment than required rate of return, then dividend policy will not affect the market value of shares as the shareholders will get the same rate of return from the firm.
Walter’s formula for determining the value of a share P
P=Market price per share, D= Dividend per share, r = internal rate of return, E= Earning per share, Ke = Cost of equity capital

13. Walter’s model CRITICISM OF WALTER’S MODEL
ASSUMPTIONS OF WALTER’S MODEL
The firm has a very long life
Earning and dividend do not change
Internal rate of return and cost of capital of the firm are constant
The investments of the firm are financed through retained earnings only
Firm does not use external sources of funds.
CRITICISM OF WALTER’S MODEL
Assumptions no. 4 & 5 is seldom true in the real world . firms do raises funds by external financing.
IRR does not remain constant.
Cost of capital Will remain constant also does not hold good.

14. 2. GORDON’S APPROACH IMPLICATIONS ASSUMPTIONS
If r > k the firm earns a higher rate of return on its investment than required rate of return, the price per share decreases as the dividend payout ratio increases.
If r < k the firm earns a higher rate of return on its investment than required rate of return, the price per share increases as the dividend payout ratio decreases.
If r = k the firm earns a higher rate of return on its investment than required rate of return, the price per share remains unchanged as it is not affected by dividend policy.
ASSUMPTIONS
The firm is an all equity firm.
No external financing is available or used
The rate of return is constant
Cost of capital for the firm is also remains constant
The firms has perpetual life
Corporate taxes do not exist

15. GORDON’S BASIC VALUATION FORMULA
P= P= price of shares , e= earning per shares , b= retention ratio ke= cost of equity capital , be=g= growth rate , do= dividend per share , d1= expected dividend at the end of year,

16. DETERMINANTS OF DIVIDEND POLICY
1. LEGAL RESTRICTIONS
2. MAGNITUDE & TREND OF EARNINGS
3. DESIRE & TYPE OF SHAREHOLDERS
4. NATURE OF INDUSTRY
5. AGE OF THE COMPANY
6. FUTURE FINANCIAL REQUIREMENTS
7. GOVERNMENT’S ECONOMIC POLICY
8. TAXATION POLICY
9. INFLATION
10. CONTROL OBJECTIVES
11. REQUIREMENTS OF INSTITUTIONALINVESTORS
12. STABILITY OF DIVIDEND
13. LIQUID RESOURCES

17. TYPES OF DIVIDEND POLICY
1. REGULAR DIVIDEND POLICY
PAYMENTS OF DIVIDEND AT THE USUAL RATE IS TERMED AS REGULAR DIVIDEND
ADVANTAGES
1. ESTABLISHES A PROFITABLE RECORD OF THE COMPANY
2. CONFIDENCEAMONGEST SHAREHOLDERS
3. LONG TERM FINANCING
4. STABLISES THE MARKET VALUES OF SHARES
2.STABLE DIVIDEND POLICY
PAYMENT OF CERTAIN MINIMUM AMOUNT OF DIVIDEND REGULARLY
FORMATS
1. CONSTANT DIVIDEND PER SHARE
2. CONSTANT PAY OUT RATIO
3. STABLE RUPEE DIVIDEND PLUS EXTRA DIVIDEND
1. SIGN OF CONTINUED NORMAL OPERATION
2. STABLISES MARKETS VALUE OF SHARES
3. CONFIDENCE AMONG THE INVESTORS
4. EASY TO MEET DAILY EXPENSES TO TOSE INVESTORS AS A SOUREC OF FUNDS
3. IRREGULAR DIVIDEND POLICY
1. UNCERTAINTY OF EARNINGS
2. UNSUCEESFUL BUSINESS OPERATIONS
3. LACK OF LIQUID RESOURCES
4. NO DIVIDEND POLICY
A company may follow a policy of not paying any dividend because of its unfavorable position of working capital management on account of requirements of funds.

18. FORMS OF DIVIDEND
(A) CASH DIVIDEND – A cash dividend is usual method of paying dividends. Payment of dividend in cash result in out flow of funds and reduces the company’s net worth, though the shareholders get an opportunity to invest the cash in any manner they desire.
(B)SCRIP OR BOND DIVIDEND A scrip dividend promises to pay the shareholders at a future specific date. In case company does not have sufficient funds to pay dividends in cash, it may issue bonds for amount due to the shareholders.
( C )PROPERTY DIVIDEND – Property dividend are paid in the form of assets other than cash. It is distributed under the exceptional case and are not popular in India.
( 4) STOCK DIVIDEND – Stock dividend means the issue of bonus shares to the existing shareholders.

19. DIVIDEND POLICY IN PRACTICE
It has been observed that the managements of Indian firms believe that dividend policy conveys information about the current and the future prospects of the form and thus affects its market value. They do consider the investor’s preference for dividends and shareholders profiles while designing the dividend policy. They also have a target dividend payout-ratio but want to pay STABLE DIVIDEND with GROWTH.

20. BONUS ISSUE
The dictionary meaning of bonus share is a premium or gifts usually of stock, by a corporation to its shareholders. A company can pay bonus to its shareholders either in the form of cash or in the form of shares. If the company so desire and article of association of the company provide, it can pay bonus to its shareholders in the form of
By making partly paid shares as fully paid.
By issuing fully paid bonus shares to existing shareholders free of cost.

21. EFFECTS OF BONUS ISSUE
Bonus paid to shareholders can be either cash or capital bonus. The effect of bonus issue is two fold -
A company gives bonus to its shareholders only when it has larger reserves and sufficient cash to pay bonus.
Capital bonus is paid when the company wants to share the accumulated reserves with shareholders but it is not in a position to pay cash bonus.
There is corresponding increase in the paid up share capital of the company .

22. CIRCUMSTANCES FOR ISSUE OF BONUS SHARES
When a company has large accumulated reserves (whether capital or revenue).
When the company is not in a position to give cash bonus.
When the value of fixed assets far exceed the amount of the capital.
When the higher rate of dividend is not advisable because shareholders will demand the same rate in future which the directors may not be able to give.
When the market price of shares far exceeds the paid up value of shares.

23. To bring down the abnormally high rate of dividend on its capital
OBJECTS OF BONUS ISSUE
To bring the amount of issued and paid up capital in line with capital employed
To bring down the abnormally high rate of dividend on its capital

24. Free Reserves that can be Used for Issue of Bonus Shares
Surplus in Profit and Loss A/c.
General Reserve.
Dividend Equalization Reserve.
Capital Reserve arising from profit on sale of fixed assets received in cash.
Balance in Debenture Redemption Reserve after redemption of debentures.
Capital Redemption Reserve A/c.
Securities premium collected in cash only.

25. Accounting Treatment
(A) If the bonus is utilized by making existing partly paid shares fully paid shares:
(i)
(Being amount transferred for bonus payable to shareholders)
(ii)
(Being final call due on shares)
Profit and Loss A/c Dr.
General Reserve A/c Dr.
Capital Profit A/c Dr.
To Bonus to Shareholders A/c
Share Final Call A/c Dr.
To Share Capital A/c

26. (iii) Bonus to shareholders A/c Dr. To Share Final Call A/c
(Being bonus to shareholders utilized to make the final call paid –up)
Bonus to shareholders A/c Dr.
To Share Final Call A/c

27. If the payment of bonus is made by the issue of free fully paid bonus shares:
(ii)
(Being issue of bonus shares)
Profit and Loss A/c Dr.
General Reserve A/c Dr.
Capital Redemption Reserve A/c Dr.
Securities Premium A/c Dr.
Capital Reserve A/c Dr.
Other reserve A/c Dr.
To Bonus to Shareholders Account
(Being amount transferred for issue of bonus shares)
Bonus to Shareholders A/c Dr.
To Share Capital A/c
To Securities Premium A/c

28. ADVANTAGES OF ISSUE OF BONUS SHARES
It makes available capital to carry an a larger business
Helps the company to get rid of market influences
Working capital not affected
Increases creditworthiness of the company
Abnormally high rate of dividend can be reduced
Restrict entry to new entrepreneurs
Balance sheet of the company reveal a realistic picture.
DISADVANTAGES OF ISSUE OF BONUS SHARES
Drastic fall in the rate of dividend
Fall in market price
Reserves and other funds decline
Leave lesser security to investors

29. RIGHT ISSUE
Subsequent issue of shares by an existing company to existing shareholders are known as rights issue.
Section 81 of the Companies Act, 1956 provides:
Where at any time after the expiry of two years from the formation of a company or the expiry of one year from the first allotment of shares in the company, whichever is earlier, the Board of Directors, decide to increase the subscribed capital of the company by the allotment of further shares , then FOLLOWING PROCEDURE MUST BE FOLLOWED:

30. PROCEDURE
1. Such further shares shall be offered to the existing shareholders proportionately to their equity holdings on that date.
2. The offer shall be made by a notice
. The offer shall be made by a notice.
3. Unless the articles of association of the company otherwise specify, the offer shall be deemed to include a right exercisable by the person concerned to renounce the shares.
4. Incase the shareholders declines to accept the shares offered, the board of directors may proceed to dispose off such shares offered in such manner as they consider most beneficial to the company.

31. Advantages of Rights Issue
The control of the company is retained in the hands of the existing shareholders.
The existing shareholders do not suffer on account of dilution in the value of their holdings if fresh shares are offered to them because value of shares is likely to fall with fresh issue.. This decrease in the value of the shares will be compensated by getting new shares at a price lower than the market price.
The expenses to be incurred, if shares are offered to the general public, are avoided.
Image of the company is bettered as existing shareholders remain satisfied.
There is more certainty of getting capital by rights issue than by when fresh issue of shares made to public.
Directors cannot misuse the opportunity of issuing new shares to their friends and relatives.

32. MAKING RIGHT ISSUE A SUCCESS
1. THE CONDITION OF THE INVESTMENT MARKET
2. THE EFFECT OF THE RIGHT ISSUE ON THE EARNING PER SHARE
3. THE SIZE OF RIGHT ISSUE
4. PRICING OF THE RIGHTS

33. VALUATION OF RIGHTS
1. FOR THE VALUATION OF RIGHT
R=Value of one right share
M=Cum- right market price of a share
S= Subscription price for a new share
N=Number of old shares required to purchase one right share
2. The ex-right value of a share can be calculated by deducting the value of right from the cum- right market price of the share
P=THEORETICAL MARKET PRICE
M=MARKET PRICE OF THE SHARE
S=NO. OF NEW SHARES FOR RIGHT SHARES
N1=Number OF OLD SHARES FOR NEW SHARES
N2= NUMBER OF NEW SHARES FOR RIGHT SHARES

34. VALUATION OF RIGHTS
3. TO CALCULATE PERCENTAGE INCREASE IN SHARE CAPITAL =
4. TO CALCULATE PERCENTAGE INCREASE IN TOTAL FUNDS

35. DIFFERENCE BETWEEN BONUS & RIGHT ISSUE
Bonus Shares
Right Shares
Bonus Shares are issued to the existing shareholders free of cost.
Existing shareholders have to pay for taking right shares.
No facility for renunciation is available.
Shareholders may renounce the right shares partly or totally.
Bonus Shares are always fully paid up.
Right Shares can be fully paid up or partly paid up.
Issue of Bonus Shares is according to the provisions of AOA and SEBI guidelines.
Issue of right shares is regulated by Section 81 of the Companies Act.
Issue of bonus shares do not increase cash because shares are issued free of cost.
Issue of right shares increases working capital
There is no requirement of minimum subscription
Issue of right shares is subject to minimum subscription

36. BONUS ISSUE Vs. STOCK SPLIT
Stock dividend means the issue of bonus shares to the existing shareholders of the company. It amounts to capitalization of earning and distribution of profits among the existing shareholders without affecting the cash position of the firm.
STOCK SPLIT
Stock split means reducing the par value of the shares by increasing the number of shares proportionately viz; a share of Rs.100 may be split into 10 shares of Rs.10 each
It does not affect the accumulated profits at all

37. BUYBACK OF SHARES
Buyback is a method of cancellation of share capital. It leads to a reduction in the share capital of a company.
Section 77 of the companies act as stood before the amendment made in 1998, imposed a blanket ban on companies from buying their own shares. Section 77 A, 77 AA & 77 B have been introduced in 1999 in the Companies Act, to enable companies to purchase their own shares or other specified securities.

38. REASONS FOR BUYBACK To shrink equity base
To prevent hostile takeover bids
To return surplus cash to shareholders
To increase the underlying share value
To support the share price during periods of temporary weakness
To achieve or maintain a target capital structure

39. ADVANTAGES OF BUYBACK
Companies having large amount of free reserves are free to use funds.
Buyback reduces companies share capital which is bloated ,thus giving more benefits to the shareholders.
Reduced capital base, increases EPS and PE ratio.
Reduced capital base leads to higher dividend yield
Buyback under section 77 B is allowed only if the liquid position of the company is good. Thus it is a good check on the companies.
Buyback provides capital appreciation to investors.
It gives a signal to the market that shares are undervalued.
Helps promoters formulate an effective defense strategy against hostile takeover bids.

40. DISADVANTAGES OF BUYBACK
Buyback implies undervaluation of shares, which creates a shortage of shares in the market.
Buybacks are announced when companies can’t find anything better to do with their cash.
Buybacks have an impact on the underlying forces on which investor behavior is based.

41. Thank you