Question

There are a few theories and explanation with regard to the impact of dividend policy on share prices. Which one is the most compelling (acceptable)for you? Why?

Answer 1

Answer :-

Dividend Policy has two types of theories

1 - Irrelevance theory which includes  Modigliani and Miller’s hypothesis

2 - Relevance theory

In Relevance Theory there are two model one is Gordan Model and Second is Walter Model

According to  Modigliani and Miller’s hypothesis theory Dividend does not affect value of the firm and according to this theory there are no taxed thats why it is also said theory of irrelevenace

and Now

Walter Model :- According to Walter Model Dividend can be calculated using P = D/K +r(E-D)/K/K

where r = rate of Return

D = Dividend

E = EPS

K = Cost of capital

According to this theory firm can finance all investments only through internally by retained earnings and also in this theory the IRR and Cost of Capital of company are always constant

Gordan Model :- According to this model the Price of share is calculated by the sum of the present value of the dividends According to this model Firm is only an equity firm there is no External financing like debt is available IRR and Discount Rate is also constant in it .

in the Model the Share price is calculated = P = D1 / (K - G)

Where D = Next year dividend

K = Cost of Capital

G = Growth Rate

According to me Gordon Model is best Besause

M & M model is saying irrelevance so lets skip it as this says dividend not affect value of firm

Now comes on Walter Model In this model if we see it mainly says all about investment decisions . It includes the Investment decisions in dividend Decisions And also it is based on various assumptions

So Gordan Model is best according to me