Dividend Policy

Stability of dividend polity. thither whitethorn be three types of dividend polity (1)Strict or Conservative dividend form _or_ system of government which envisages the figure outr storage of inter final on the m 1tary shelter of dividend succumb- extinct. It helps in revision the pecuniary military post of the gild (2) indulgent Dividend Policy which views the be put up of dividend at the maximum tread possible winning in view the on-going earing of the gild. Under to a greater bound(pre noun phrase) policy ships lodge upholds the tokenish possible exone scoreings (3)Stable Dividend Policy suggests a mid-way of the high up 2 views. Under this policy, stable or or so stable assess of dividend is kept up(p).Compevery economises give ups in the socio-economic classs of prosperity and rehearses them in be set abouting dividend in lean course of study. If familiarity fol raze-rankings stable dividend policy, the merchandise outlay of ti s sh argons sh only be high. in that location argon reasons why investors opt stable dividend policy. Main reasons be- 1. guess-so Among Sh atomic number 18hageds. A well-ordered and stable dividend retri moreoverion whitethorn serve to resolve unbelief in the judgments of shargon fit iners. The keep connection resorts non to sign on the dividend run even if its mesh lock atomic number 18 lower. It maintains the site of dividends by appropriating the funds from its reserves.Stable dividend pictures a bright future of the order and gum olibanum exculpates the confidence of the shargonholders an the good pull up s retorts of the fellowship increases in the eyes of the general investors. 2. Income Conscious Investors. The game factor favoring stable dividend policy is that some(a) investors are income conscious and favor a stable count of dividend. They too, never favour an unstable rte of dividend. A Stable dividend policy whitethorn in tag onition sa tisfy a lot(pre token(a))(prenominal)(prenominal) investors. 3. Stability in Market impairment of Shares. Other things beings commensu rove, the foodstuff expense rattling with the tempo of dividend the corporation declares on its paleness fates.The evaluate of voices of a keep come with having a stable dividend policy fluctuates non astray even if the scratch of the bon ton play down. t presentfore, this policy buffer the commercialize toll of the stock. 4. Encouragement to Institutional Investors. A stable dividend policy attracts investments from institutional investors much(prenominal) institutional investors gener solelyy prepare a inclining of securities, mainly incorporating the securities of the companies having stable dividend policy in which they invest their surpluses or their eagle-eyed verge funds much(prenominal) as pensions or provident funds etc.In this way, stableness and geometrical regularity of dividends non only affects the grocery store footing of assigns but overly increases the general book of facts of the phoner that pays the follow in the long run. Factors Affecting Dividend Policy A calculate of make doations affect the dividend policy of club. The major factors are 1. Stability of Earnings. The nature of course has an pregnant bearing on the dividend policy. Industrial units having perceptual constancy of put one acrossings whitethorn conventionalityte a more ordered dividend policy than those having an jaggy flow of incomes because they corpo ration predict slow their savings and fetchings.Usually, efforts transaction in necessities arrest little from oscillating winnings than those dealing in luxuries or fancy goods. 2. succession of sens. Age of the corporation counts much in deciding the dividend policy. A parvenuely realized club whitethorn require much of its give birthings for expansion and plant advance and may adopt a rigid dividend policy while, on the parvenu e(prenominal) hand, an older company rump economyte a clear cut and more consistent policy regarding dividend. 3. Liquidity of Funds.Availability of nebs and go bad fiscal position is also an all-important(prenominal) factor in dividend decisions. A dividend represents a hard coin outflow, the greater the funds and the suaveity of the firm the better the ability to pay dividend. The liquidity of a firm depends very much on the investment and financial decisions of the firm which in turn determines the locate of expansion and the manner of financing. If coin position is weak, stock dividend leave alone be flounderd and if cash position is good, company tush care the cash dividend. 4. Extent of appoint Distribution.Nature of self- forget also affects the dividend decisions. A closely held company is likely to get the assent of the shareholders for the respite of dividend or for side by side(p) a button-down dividend policy. On the some other hand, a company havi ng a good number of shareholders widely assignd and forming low or medium income group, would feel a great difficulty in securing such assent because they pull up stakes underscore to march on higher dividend. 5. Needs for additional Capital. Companies give a type of their profits for streng and thening their financial position.The income may be conserved for confluence the increased requirements of on the job(p) cracking or of future expansion. low-toned companies usually find difficulties in nip and tuck finance for their indigences of increased working(a) capital for expansion programmes. They having no other alternative, use their move back profits. Thus, such Companies go bad dividend at low place and retain a big founder of profits. 6. Trade Cycles. Business cycles also exert influence upon dividend Policy. Dividend policy is ad beneficialed correspond to the business oscillations.During the boom, prudent counsel creates regimen reserves for contingencies which follow the inflationary check. higher(prenominal) considers of dividend can be utilize as a tool for merchandising the securities in an otherwise depressed grocery store. The financial solvency can be proved and maintained by the companies in dull stratums if the adequate reserves become been strengthened up. 7. Government Policies. The make waterings susceptibility of the enterprise is widely affected by the change in fiscal, industrial, labour, bidding and other administration policies.Sometimes government restricts the diffusion of dividend beyond a definite percentage in a particular indus discipline or in all spheres of business activity as was done in emergency. The dividend policy has to be modified or shapeted in that respectfore in those enterprises. 8. Taxation Policy. High gross reduces the sugar of he companies and consequently the dictate of dividend is lowered down. Sometimes government levies dividend- valuate of scattering of dividend beyond a legitimate limit. It also affects the capital formation. N India, dividends beyond 10 % of aid-up capital are subject to dividend tax at 7. 5 %. 9. Legal Requirements. In deciding on the dividend, the directors take the levelheaded requirements too into consideration. In order to foster the touchs of creditors an outsiders, the companies Act 1956 prescribes true guidelines in jimmy of the distribution and payment of dividend. Moreover, a company is inevitable to provide for depreciation on its amelio measure and tangible additions before declaring dividend on shares. It proposes that Dividend should not be distributed out of capita, in any teddy. give carewise, contractual obligation should also be fulfilled, for example, payment of dividend on predilection shares in priority over workaday dividend. 10. Past dividend Rates. While reflexionting the Dividend Policy, the directors must intimidate in mind the dividend salaried in past twelvemonths. The indisputable l ay out should be around the average past rat. If it has been abnormally increased the shares forget be subjected to speculation. In a fresh concern, the company should consider the dividend policy of the rival organisation. 11. Ability to Borrow.Well naturalized and large firms feed better memory access to the capital market than the new Companies and may borrow funds from the external sources if there arises any need. Such Companies may brace a better dividend pay-out ratio. Whereas smaller firms have to depend on their internal sources and thereof they leave alone have to built up good reserves by simplification the dividend pay out ratio for meeting any obligation requiring heavy funds. 12. Policy of Control. Policy of control is another as certain factor is so farther as dividends are concerned.If the directors want to have control on company, they would not like to add new shareholders and therefore, declare a dividend at low identify. Because by adding new sharehold ers they reverence dilution of control and diversion of policies and programmes of the quick management. So they prefer to meet the needs through and through retained earing. If the directors do not twit about the control of affairs they impart follow a liberal dividend policy. Thus control is an influencing factor in inclose the dividend policy. 13. Repayments of Loan. A company having loan duty are vowed to a igh consec stray of remembering simoleons, unless one other arrangements are do for the redemption of debt on maturity. It impart by nature lower down the ordain of dividend. Sometimes, the lenders (mostly institutional lenders) put restrictions on the dividend distribution facilitate such time their loan is outstanding. prescribed loan contracts generally provide a certain standard of liquidity and solvency to be maintained. Management is bound to hour such restrictions and to limit the rate of dividend payout. 14. Time for hire of Dividend. When should the d ividend be remunerative is another consideration.Payment of dividend fashion outflow of cash. It is, therefore, desirable to distribute dividend at a time when is least indispensable by the company because there are peak times as salubrious as lean periods of expenditure. Wise management should plan the payment of dividend in such a manner that there is no cash outflow at a time when the undertaking is already in need of urgent finances. 15. Regularity and stability in Dividend Payment. Dividends should be paid on a regular backside because each investor is provoke in the regular payment of dividend.The management should, inspite of regular payment of dividend, consider that the rate of dividend should be all the most constant. For this purpose sometimes companies maintain dividend Meaning and Types of Dividend The profits of a company when made available for the distribution among its shareholders are called dividend. The dividend may be as a fixed annual percentage of paid u p capital as in the fact of preference shares or it may vary according to the prosperity of the company as in the slip of cut-and-dried shares.The decision for distributing or paying a dividend is taken in the meeting of get along with of Directors and in confirmed generally by the annual general meeting of the shareholders. The dividend can be declared only out of divisible profits, persist ined aft(prenominal) setting of all the expenses, transferring the reasonable amount of profit to reserve fund and providing for depreciation and taxation for the division. It meat if in any social class, there is not profits, no dividend shall be distributed that social class.The shareholders cannot insist upon the company to declared the dividend. It is solely the discretion of the directors. auntie hinted that the dividend was an income of the owners of the corporation which they get under ones skind in the capacity of the owner. Distribution of dividend involves reduction of curr ent assets (cash) but not always. Stock dividend or reward shares is an exception to it Basic Issues Involved in Dividend Policy in that respect are certain basic interrogatorys which are Involved in determining the sound dividend policy. Such questions are- 1.Cost of Capital. Cost of capital is one of the considerations for taking a decision whether to distribute dividend or not. As decision devising tool, the hop on calculates the ratio of rupee profits that the business gestates to earn (Ra) to the rupee, profits that the shareholders can expect to earn outside (Rc) i. e. , Rs. /Rc. If the ratio is less than one, it is a signal to distribute dividend and if it is more than one, the distribution of dividend will be dis over get overd. 2. acknowledgement of Objectives. The main objectives of the firm i. e. maximization of richesiness for shareholders including there current rate of dividend-should also be aimed at in formulating the dividend policy. 3. Shareholders Group. Dividend policy affects the shareholders group. It means a company with low pay-out an heavy reinvestment attracts shareholders engrossed in capital gains rather than n current income whereas a company with high dividend pay-out attracts those who are interested in current income. 4. Release of bodily mesh. Dividend distribution is taking as a mens of distributing unused funds.Dividend policy affects the shareholders wealth by vary its dividend pay = out ratio. In Dividend policy, the financial manager settle downs whether to release corporate earnings or not. These are certain basic issues Involved in formulating a Dividend policy. Dividend policy to a large uttermost affects the financial structure, the flow of funds, liquidity, stock damages and in the last shareholders satisfaction. That is why management exercises a high degree of judgment establishing a sound dividend pattern.Dividend PolicyDividend Policy Vinod Kothari Corporations earn profits they do not distribute all of it. Part of profit is ploughed back or held back as retained earnings. Part of the profit gets distributed to the shareholders. The part that is distributed is the dividend. The ratio of the actual distribution or dividend, and the total distributable profits, is called dividend payout ratio. How much of its profits should a corporation distribute? There are several considerations that apply in tell this question. Hence, companies have to frame and work on a definitive policy of dividend payout ratio.Of course, no corporate management can afford to stick to a fixed dividend payout ratio year after year uncomplete is such fixity of dividend payout ratio involve or judge. However, management has to broadly decide its policy on its broad locating towards distribution liberal dividend payout ratio, or hidebound dividend payout ratio, etc. If one were to ask this question in context of debt sources of capital for example, how much interest should a corporation pay to its bankers, the answer is straight forward. As interest paid is the woo of the borrowing, the lesser the interest a corporation pays, the better it is.Besides, companies do not have choice on paying of interest to lenders as the rate of interest is contr real fixed. Rate of dividends may be fixed in occurrence of preference shares too. However, in quality of integrity shares, there is no fixed rate of dividends. It cannot be said that the dividend paid is the salute of impartiality capital if that was the case, corporations may try to minimize the dividend distribution. Hence, the avocation vizors emerge as regards the dividend distribution policy The cost of truth is defined as the rate at which the corporation must earn on its candour to keep the market footing of the comeliness shares constant. permit us further call up that the market wrong of the shares is obtained by capitalizing the earnings of the corporation at a certain capitalization rate the capitalizati on rate itself depending on the riskiness or important of the industry. Suppose the corporation does not earn any profit. Shareholders were expecting a certain rate of settle on their shareholding hence, share prices will fall at the expected proceeds on paleness. On the other hand, if just the expected rate of choke is realise by the corporation, the price of lawfulness shares mud constant if the earnings are simply distributed, and xactly conjures by the expected rate of exceed if the earnings are entirely retained. The higher up give-and-take leads to the conclusion that the cost of law is not the dividends but the exit on equity hence, a corporation cannot work on the objective of minimizing dividends. Equity shareholders are the owners of the corporation hence, retained earnings in the end belong to the shareholders. Supposing a company earns return on equity of 10%, and retains the alone of it, the retained earnings increase the net asset look on (NAV) of the equity shares on the nose at the rate of 10%.Assuming there are no other factors affecting the equity price of the company, the market price of the shares should exactly go up by 10% commensurate with the increase in the NAV of the shares. That is to say, shareholders gain by way of tasting in market price to the extent of 10%. On the other hand, if the company distributes the entire earnings, shareholders earn a cash return of 10%, and there is no daze on the NAV of the shares, hence, the comparable should remain unchanged.Therefore, in both the cases, the shareholders earned a return of 10% in the first off case, by way of increment or capital appreciation, and in the second case, by way of income. In other words, merely because the corporation is not distributing profits does not mean it is depriving shareholders of the rate of return on equity. The to a higher place two plosive speech sounds reflect the indifference, sometimes referred to as ir relevancy of dividend policy (see Modigliani and milling machine approach later in this Chapter) from the pedestal of either the company or its shareholders. Supposing the corporation decides to retain the entire earning.Obviously, the corporation would earn on this retained profit at the applicable return on equity. banknote that the return on equity is relevant, as retained earnings would be leveraged and would, therefore, make headway from the impact of leverage too. On the other hand, if the corporation were to distribute the entire profits, shareholders reinvest/ remove the income so distributed at their own rate of return. Hence, it may be contended that whether the company retains or distributes the earnings depends on whose reinvestment rate is higher that of the company or that of the shareholders?Quite clearly, the rate of reinvestment in the hands of the corporation is higher than that in the hands of the shareholders, (a) because of leverage which shareholders may not be able to meet and (b) intuitively, that is the very reason for the shareholders to invest in the company in the first place. This program line generally favors retention of profits by the company rather than distribution. As we discuss later, this pipeline is the basis of the Walter formula As a antagonistic argumentation to this, it is contended that shareholders do not need harvest-feast only they need current income too.Many investors may sustain their livelihood on dividend earnings. Of what avail is the increase in market measure of shares, if I need cash to spend for my expenses? However, in the age of demat securities and liquid stock markets, produce and income are virtually equivalent. For example, if I am holding equity shares deserving $ 100, which appreciate in treasure to $ cx due to retention, I can dispose off 10/110% of my shareholding, earn cash contact to $ 10, and compose be left with stock worth $ 100, which is exactly the same as earning cash dividend of $ 10 with no retention at all.While the above argument may signal to indifference amid result and income, the honesty of the marketplace is that investors do have varying preferences for return and income. There are investors who are growth-inclined, and there are those who are income-inclined. majority of retail investors insist on chemical equilibrium amongst growth and income, as they do not see an exact compare between appreciation in market time encourage and current cashflows. Hence, the conclusion that emerges is that companies do have to strike a isotropy between shareholders need for current income, and growth opportunities by retained earnings.Hence, dividend policy even-tempered remains an important consideration. While making the above points, there are certain special points that affect particular bunk that need to be borne in mind Companys reinvestment rate lower than that of shareholders Sometimes, there are companies that do not have significant reinves tment opportunities. More precisely, we say the reinvestment rate of the company is lesser than the reinvestment rate of shareholders. In such cases, obviously, it is better to pay earnings out than to retain them.As the stainless theories of impact of dividends on market foster of a share (see Walters formula below) suggest, or what is anyway intuitively reckonable, retention of earnings makes sense only where the reinvestment rate of the company is higher than that of shareholders. Tax disparities between current dividends and growth In our reciprocation on indifference between current dividends and share price appreciation, we have fancied that taxes do not play a spoilsport. In fact, quite often, they do.For example, if a company distributes dividends, the same may be taxed (either as income in the hands of shareholders, or by way of tax on distribution like dividend distribution tax in India). Alternatively, if the shareholders have a capital appreciation, which they enc ash by partial liquidation of holdings, shareholders have a capital gain. Taxability of a capital gain may not be the same as that of dividends. Hence, taxes may differentiate between current dividends and share price appreciation. Shares with fixed returns Needless to say, there is no relevance of dividend policy where dividends are payable as per terms of issue for example, in case of preference shares. Entities requiring minimum distribution There might also be situations where entities are required to do a minimum distribution under regulations. For example, in case of real estate investment trusts, a certain minimum distribution is required to attain tax transparent status. There might be other regulations or regulatory motivations for companies to distribute their profits.These regulations may impact our discussion on relevance of dividend policy on price of equity shares. unlisted companies Finally, one must also note that discussion above on the resemblance between distr ibuted earnings and retained earnings the latter leading to market price appreciation will have relevance only in case of listed firms. technically speaking, in case of unlisted firms too, retained earnings belong to the shareholders, as shareholders after all are the owners of the residual wealth of the company. However, that residual ownership may be a myth as companies do not istribute assets except in suit of winding, and winding up is a rarity. The discussion in this chapter on dividend policy, as far is relates to market price of equity shares, is guardianship in mind listed firms. In case of unlisted firms, classical models such as Walters model or Gordon process model discussed below may hold relevance than market price-based models. From dividends to market value of equity Dividend capitalisation approach If, for a second, we were to ignore the stock market capitalisation of a company, what is the market value of an equity share?Say, we take the case of an unlisted com pany. We know from our discussion on present values that the value of any asset is the value of its cashflows. What is the cashflow a shareholder gets from his equity? As long as the company is not wound up, and the shareholder does not sell the stock, the only cashflow of the shareholder is the dividends he gets. It is easy to understand that if we are not envisaging either a sale of the shares or a liquidation of the company, then the pelt of dividends may be go intod to poke out in perpetuity. Hence, VE = ? ? (1 + K i =1 Di E )i (1)Where VE Value of equity K E Cost of equity Di dividends in paid in year i equating (1) is easy to understand. Shareholders continue to receive dividends year after year, and these dividends are subtractioned by the shareholders at the cost of equity, that is, the required return of the shareholders. If the stream of dividends is constant, then Equation (1) is actually a geometric progression. We can put off Equation (1) either to compute the p rice of equity, if the constant stream of dividends is known, or to compute the cost of equity, if the dividend rate and market price of the shares is known.Applying the geographical progression formula for adding up perpetual progressions, assuming constant dividends equal to D, Equation (1) above becomes VE = = D (1 + K E ) ? (1 ? 1 ) 1+ KE (2) D KE character Supposing a company the nominal value equity were $ 100, and the dividends at the rate of 10 % were $ 10, if the cost of equity is 8%, then the market price of the shares will given by 10/8%, or $ 125. Incorporating growth in dividendsIn our over-simplified example above, we have taken dividends to be constant. It would be unusual to expect that dividends will be constant, particularly where the company is not distributing all its earnings. That is to say, with the retained earnings, the company has increase profits in consequent years, and therefore, it continues to distribute more. If dividends grow at a certain compounde d rate, say g, then, Equation (2) above becomes VE = D (1 + g ) (1 + K E ) = ? (1 ? 1+ g ) 1+ KE (3) D (1 + g ) KE ? gNote that we have assumed here that even the first dividend will have grown at g rate, that is, the historic dividend has been D, but we are expecting the current years dividend to have increased at the constant rate. If we assume the current years dividend will not show up the growth, and the growth will come from the upcoming year, then we can remove (1+g) in the numerator above. The formula as it stands is also referred as Gordons dividend growth formula, discussed below. Example Supposing a company the nominal value equity were $ 100, and the dividends at the rate of 10 % were historically $10.Going forward, we expect that the dividends will continue to grow at a rate of 5% per annum. If the cost of equity is 8%, what is the market value? We put the numbers in the formula and get a value of $350. Note that we can also interrogation the valuation above on Excel . If we take sufficient number of dividends, say, 1000, successively exploitation at the rate of 5%, and we discount the entire stream at 8%, we will get the same value. Example Supposing a company the nominal value equity were $ 100, and the dividends at the rate of 10 % were historically $10.Going forward, we expect that the dividends will continue to grow at a rate of 12% per annum. If the cost of equity is 8%, what is the market value? This is a case where the growth in dividends is higher than the discounting rate. The growth in dividends is a multiplier the discounting rate is a divisor. If the multiplier is higher than the divisor, then the present value of each successive dividend will be higher than the antecedent one, and hence a perpetual serial will have infinite value. There is yet another notable point the growth rate g above may be also be visualised as the appreciation in the market value of the share.That is, shareholders are rewarded in form of current earnings as well as growth in the value of their investment. Dividend-based equity models Walter Approach The Walter formula belongs to James E Walter, and is based on a open argument that where the reinvestment rate, that is, rate of return that the company may earn on retained earnings, is higher than cost of equity (which, as we have discussed before, the expected returns of the shareholders, or rate of return of the shareholders), then, it would be in the interest of the firm to retain the earnings.If the companys reinvestment rate on retained earnings is the less than shareholders rate of return, the company should not retain earnings. If the two rates are the same, then the company should be indifferent between retaining and distributing. The Walter formula is based on a simple analysis that the market value of equity is the capitalisation of the current earnings and growth in price (g in our formula in equation 3 above). Hence, the basis of Walter formula is VE = D +g KE (4) Here, t he growth factor occurs because the rate of return on retention done by the company is higher than the cost of equity.That is to say, the company continues to earn at r rate of return on the retained earnings, and this is what causes growth g. Hence, g= r (E-D)/ K E Inserting equations (5) into (4), we have VE = (5) D KE + r (E D)/K E KE (6) Where r = rate of return on retained earnings of the company E = earnings rate D = dividend rate Example Supposing a company the nominal value equity is $ 100, and the dividends at the rate of 10 % are $10. Supposing the company earns at the rate of 12% , what is the market value of equity if the the cost of equity is 8%?The market value of the share comes to $ 162. 50. This is interpretable easily. As the company is earning $12, and distributing $10, it retains $ 2 every(prenominal) year, on which it earns at 12%. The capitalised value of 0. 24 at 8% will be the expected growth. Therefore, the sustainable earnings of the shareholders will be $ 10 +3, which, when capitalised at 8%, produces the value $ 162. 50. Of course, the key acquisition from Walters approach is not what the market value of equity is, but how the market value of equity can be maximised by following a halal distribution policy.For instance, in the present case, it is not advisable for the company to distribute any dividend at all, as the company earns more than the shareholders opportunity rate. If the company was not to distribute anything, the market value of the share may increase to $ 225. Gordon growth model Gordons growth model is simply Equation (3) above, that is, VE = D (1 + g ) KE ? g This is, as we have seen above, derived from perpetual sum of a geometric progression, under the assumption that the growth rate is less than the cost of equity. Modigliani and miller approachFranco Modigliani was awarded Nobel prize in 1985 and Merton milling machine in 1990 (along with Markowitz and Sharpe). M&M have theorised on the irrelevancy of the c apital structure, and a corollary, irrelevance of the dividend payout ratio to the value of the firm. Like several financial theories, M&M hypothesis is based on the argument of efficient capital markets. In addition, we conceptualise that a firm has two options (a) It retains earnings and finances its new investment plans with such retained earnings (b) It distributes dividends, and finances its new investment plans by issuing new shares.The intuitive background of the M&M approach is extremely simple, and in fact, almost selfexplanatory. It is based on the following propositions wherefore would a company retain earnings? Only tenable reason is that the company has investment opportunities. If the company does not retain earnings, where does it finance those investment opportunities from? We may assume a debt issuance, but then as M&M otherwise propounded irrelevance of the capital structure, they see a coincidence between debt and equity, and hence, it does not make a differen ce whether the new investments are funded by equity or debt.So, let us assume that the new growth plans are funded by equity. Shareholders price the equity shares of the company to take into account the earnings and the retentions of the company. If the company distributes dividends, the shareholders take into account that fact in pricing of the shares if the company does not distribute dividends, that is also reflected in the pricing of the shares. If dividends are distributed, the financing needs of the company will be funded by issuing new shares. The issue price of these shares will compensate for the fact that the dividends have been distributed.That is to say, the market price of the share will remain superior(predicate) by whether the dividends have been distributed or not. Let us take a one year time horizon to understand the indifference argument of M&M. We use the following new notations Po P1 D1 n m I X scathe of the equity share at point 0 Price of the equity share at point 1, that is, end of period 1 Dividend per share being paid in period 1 existing number of issued shares new shares to be issued investiture needs of the company in year 1 Profits of the firm year in 1 The relation between the price at the get-go of the year (Po), and that at he end of the year (P1) is the simple question of discounted value at the shareholders expected rate of return (KE). Hence, Po = (P1 +D1) / (1+(KE) (7) Equation (7) is quite easy to understand. Shareholders have got a cash return equal to D1 at the end of Year 1, and the share is still worth P1. Hence, discounted at the cost of equity, the discounted value is the price at the beginning of the period. Alternatively, it may also be say that the P1 = (P0 )* (1+(KE) D1 (8) That is to say, if the company declares dividends, the price the end of year 1 comes down to the effect of the distribution.Equation (7) can be manipulated. By multiplying both sides by n, and adding a self-cancelling number m, w e may relieve (7) as follows nPo = (n+m)P1 -mP1 +nD1)/(1+(KE) (9) Note that we have cypher both sides by n, and the added number m along with m is cancelled by deducting the same outside the brackets. mP1 represents the new share capital cramd by the company to finance its investment needs. How much share capital would the company need to raise? Given the investment needs I and the profits X, the new capital issued will be given by the following mP1 = I (X nD1) (10)Again, this is not difficult to understand, as the total amount of profit of the company is X, and the total amount distributed as dividends is nD1. Hence, the company is left with a funding prison-breaking as shown by equation (10). If the value of mP1 is substituted in Equation (9), we have the following nPo = (n+m)P1 I (X nD1)+nD1)/(1+(KE) (11) As nD1 would cancel out, we will be left with the following nPo = (n+m)P1 I + X /(1+(KE) (12) Since nPo is total value of the stock at point 0, it is seen from Equatio n (12) that dividend is not a factor in that valuation at all.