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The following information is available in respect of the rate of return on investment (r), the cost of capital (k) and earning per share (E) of ABC Ltd. Rate of return on investment (r) = (i) 15%; (ii) 12%; and (iii) 10%. Before publishing your articles on this site, please read the following pages: 1. Retained earnings represent the only source of financing investment programmes. Read More. This concept is supported by Franco Modigliani and Morton H. Miller and E. Solomon According to E. Solomon, the dividend policy of the firm is a residual decision, Residual Theory and dividends are a passive residual.’ In other words, dividend policy has no effect on the prices of shares of a company and, as such, it has no significance. The required rate of this company’s shareholders is 10 percent. (v) The cost of capital for the firm remains constant and it is greater than the growth rate, i.e. Stockholders often act on the principle that a bird in hand is worth than two in the bushes and for this reason are willing to pay a premium for the stock with the higher dividend rate, just as they discount the one with the lower rate.”. After that time it is expected that the company could pay dividend of Rs. Dividend on Shares - Get Get topics notes, Online test, Video lectures & Doubts and Solutions for ICSE Class 10 Mathematics on TopperLearning. ke=10%; (ii) r is 8%, i.e., r> [SOUND] A dividend is a distribution of money from the company's earnings to its shareholders. Determine the market price of the shares today. When the rate of return of firm on its investment is greater than the required rate of return, i.e., when r > k, the price per share increases as the dividend payout ratio decreases. This can be put in the form of the following formula: Where P0 = Market price per share at the beginning of the period, or prevailing market price of a share. In case of profit, preference shareholders are entitled to get dividend at a fixed rate as per terms of their issue. Shareholders will get dividends in proportion to their shareholding in the company. Dividend decision is the financing decision of a business. P1 = Market price per share at the end of the period. Academic Partner. Dividend may be in the form of cash or non-cash, i.e. In the words of Krishnan, John, E. “of two stocks with identical earnings, record, prospects, but the one paying a larger dividend than the other, the former will undoubtedly command a higher price merely because shareholders prefer present to future values. Their basic desire is to earn higher Return on their investment. Expandent Ltd. had 50,000 equity shares of Rs. Privacy Policy 9. Thus, the growth rate of the firm g = br, is also constant. Copyright 10. k > br. … Thus, for a normal firm there is no optimum dividend payout. n = number of shares outstanding at the beginning of the period. It belongs to a risk- class whose appropriate capitalisation rate is 15%. Calculate the dividend growth rate, if its capitalisation rate is 12 percent. Essentially, the company divides its total number of dividends by the total number of shares. This argument is described as bird-in-the hand argument, i.e. Prohibited Content 3. Thus, if dividend policy is considered in the context of uncertainty, the cost of capital cannot be assumed to be constant and so firm should set a high dividend payout ratio and offer a high dividend yield in order to minimise its cost of capital.

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