Financial Management and Strategy

School

Nnamdi Azikiwe University

Course Title

Financial Management And Strategy

Pius Vincent Chukwubuikem Okoye

Audio by Paper2Audio.

Unit 3 Capital Budgeting

- □ Introduction

- □ Objectives

- □ Main Content

Caveats on Applying Option Pricing Models

- The Option to Delay a Project

- The Option to Expand a Project

- The Option to Abandon a Project

- □ Conclusion

- ☐ Summary

- □ References / Further Reading

□ Introduction

- ❖ Very smart recap of previous units, we identified and discussed short and medium term business financing.

- Firms consideration projects.

- □ Opportunities and future receipe/prospects of the Projects

- Options and financing choices

- Financing choices,

- Firms are valued inline with their products and customers reactions

Objectives

- Explain capital budgeting

- Explain what are the options embedded in capital budgeting.

- Explain how these options can be valued using option pricing models

- Identify how these values can be used in conjunction with traditional capital budgeting analysis.

Caveats on Applying Option Pricing Models

- Offering a few caveats on the application of option pricing models

- Adjustments

- Options being valued are not on financially traded assets (such as stocks or commodities).

- ❖ Real Option: A real option is an option on a non-traded asset, such as an investment project or a gold mine.

Option pricing theory, as presented in both the binomial and the Black – Scholes models - built on the premise that a replicating portfolio can be created using the underlying asset and riskless lending and borrowing.

The Price of the Asset Follows a Continuous Process

☐ The Black – Scholes option pricing model is derived under the assumption that the underlying asset's process is continuous (i.e., there are no price jumps).

☐ If this assumption is violated, as it with most real options, the model will underestimate the value of deep out of the money options and lower variance estimates for at the money or in the money options.

□ Another solution is to use an option pricing model that explicitly allows for price jumps, although the inputs to these models are often difficult to estimate.

The variance is known and does not change over the life of the options

□ Option pricing models assume that the variance is known and does not change over the option lifetime:

☐ This assumption is not unreasonable when option pricing theory is applied to longterm real options however, □ Problems may arise with this assumption, for the variance is unlikely to remain constant over extended periods of time and may in fact be difficult to estimate in the first place.

□ Modified versions of the option pricing model exist that allow for changing variances, but they require that the process by which variance changes be modeled explicitly.

Exercise is instantaneous

- ☐ The option pricing models are based on the premises that the exercise of an option is in stantaneous.

- □ This assumption may be difficult to justify with real options, however; exercise may require building a plant or constructing an oil rig, for example, actions that do not.

- □ Occur in an instant.

- ☐ The fact that exercise takes time also implies that the true life of a real option is often less than the stated life.

- ☐ Thus, although a firm may own the rights to an oil reserve for the next 10 years, the fact that it takes several years to extract the oil reduces the life of the natural resource option the firm owns.

The Option to Delay a Project

□ Projects are typically analyzed based on their expected cash flows and discount rates at the time of this analysis.

☐ The net present value computed on that basis is a measure of its value and acceptability at that time.

□ Expected cash flows and discount rates change over time, however, as does the net present value. Thus, a project that has a negative present value now may have a positive net present value in the future.

☐ In a competitors in taking projects, this may not seem significant. In an environment in which a project can be taken by only one firm (because of legal restrictions or other barriers to entry to competitors), however, the changes in the project's value over time give it the characteristics of a call option.

□ Assume that a project requires an initial investment of X (in real dollars) and that the present value of expected cash inflows computed right now is P.V. The net present value of this project is the difference between the two:

N.P.V = P.V - X

Now assume that the firm has exclusive rights to this project for the next 10 years and that the present values of the cash inflows may change over that time because of changes in either the cash flows or the discount rate. Thus, the project may have a negative net present value right now, but it may still be a good project if the firm waits. Defining V as the present value of the cash flows, we can summarize the firm's decision rule on this project as follows:

If v greater than x Project has positive net present value

V less than x Project has negative net present value

Assuming that the firm holds out until the end of the period for which it has exclusive rights to the project.

Note a call option – the underlying asset is the project; the strike price of the option is the investment needed to take the project; and the life of the option is the period for which the firm has rights to the project. The present value of the cash flows on this project and the expected variance in this present value represent the value and variance of the underlying asset.

Option to Expand a Project

☐ In most cases, firms take multiple projects to enter other markets in the future.

☐ In such cases, it can be argued that the initial projects are options allowing the firm to take other projects, and the firm should therefore be willing to pay a price for such options. A firm may accept a negative net present values on future projects.

□ To examine this option using the same framework developed earlier, assume that the Pv of the expected cash flows from entering the market or taking the new project is V, and that the total investment needed to enter this market or take this project is X, □ Furthermore, assume that the firm has a fixed time horizon, at the end of which it has to make the final decision on whether or not to take advantage of this opportunity. Finally, assume that the firm cannot move forward on this opportunity if it does not take the initial project.

□ This scenario implies the option of payoffs - at the expiration of the fixed time horizon, the firm will enter the new market or take in the new project if the present value of the expected cash flows at that point in time exceeds the cost of entering the market.

The Option to Abandon a Project

- When its cash flows do not measure up to expectations.

- Generally increase the value of a project

- Make it more acceptable.

Exercise

Option to abandon, let V be the remaining value on a project if it continues to the end of its life, and L the liquidation or abandonment value for the same project at same point in time. If the project has a life of n years, the value - if it is higher, the project should be continued; if it is higher, the project should be continued; if it is lower, the holder of the abandonment option could consider abandoning the project.

Payoff from owning an abandonment option equals zero if V is greater than L, and it equals L minus V if V is less than or equal to L

Illustration

Assume that a firm is considering taking a 10 year project that requires an initial investment of 100 million dollars in a real estate partnership, and where the present value of expected cash flows is 110 million dollars. Although the net present value of 10 million dollars is small, assume that the firm has the option to abandon this project anytime (by selling its share back to the other partners) in the next 10 years; if abandoned, the net salvage value of the project is 50 million dollars. The variance in the present value of the cash flows from being in the partnership is 0.06.

The value of the abandonment option can be estimated by determining the characteristics of the put option:

Value of the underlying asset (s) =P.V of cash flows from project =$110 million

Strike price (k) = Salvage value from abandonment = $50 million

Variance in underlying asset's value =0.06, Time to expiration = Life of the project = 10 years

Dividend yield = 1 per Life of the project = 1/10 (we are assuming that the project's present value will drop by roughly 1/n each year into the project)

Assume that the 10year riskless rate is 7%. The value of the put option can be estimated as follo ws:

Call Value = 110 exp (0.10) (10) (0.8455) -50 exp (-0.07) (10) (0.5961) =$ 19.41 million

Put Value equals 19 dollars and 41 cents minus 110 times the exponential of negative point 10 times 10 plus 3 dollars and 77 cents million The value of this abandonment option has to be added on to the net present value of the project of 10 million dollars, yielding a total net present value with the abandonment option of 13.57 million dollars. Note, however, that abandonment becomes a more and more attractive option as the remaining project life decreases, since the present value of the remaining cash flows will decrease.

Practical considerations:

- Above analysis, was assumed, & unrealistically.

- Abandonment value was clearly specified up from

- No change during the life of the project.

- May be true in some very specific cases

- if an abandonment option is built into the contract.

- Firms have the option to abandon, and the salvage value can be estimated ed up front

- Abandonment value may change over the life of the project

- Difficult to apply traditional option pricing techniques.

- Possibility that abandoning a project may not bring in a liquidation value

- It may create costs instead

- Firm may have to pay severance to its workers

- Would not make sense to abandon, unless

- The cash flows on the project are even more negative.

Implications

- ✓ The fact that the option to abandon has value, it provides a rationale for firms to build the flexibility to scale back or terminate projects if they do not meet expectations.

- ✓ Firms can do this in a number of ways.

- The first, and most direct way, is to build in the option contractually with those parties that are involved in the project. Thus, contracts with suppliers may be written on an annual basis rather than long term, and employees may be hired on a temporary basis rather than permanently.

- The physical plant used for a project may be leased on a short-term basis rather than bought, and

- the financial investment may be made in stages rather than as an initial lump sum.

- Building in this flexibility carries a cost, but the gains may be much larger, especially in volatile businesses.

Conclusions

Table summary: Investment projects can incorporate three distinct options to delay, expand, or abandon the project, all of which add value to the underlying asset. Furthermore, equity can be conceptualized as a call option on the firm, meaning it retains value even when the total firm value is lower than the value of outstanding claims.

Summary

Choosing projects can be tasking and critical

Projects create opportunities in the future

Opens up new markets

Expanding existing marketing.

Sends better market signal of Growth

Promotes Leadership Discipline

Restore Trust and morel Confidence

• Grows Goodwill

Table summary: Strategic financial management practices and the way forward. Key operational focus areas include implementing sound financial management, maintaining financial discipline and planning, focusing on firm objectives, goals, and reviews, and applying sound resource rationing, portfolio management, and monitoring. The way forward for these practices is centered on training, advocacy, and review.

References/Further Reading

Thanks for Listening

Nnamdi Azikiwe University

Course Title

Financial Management And Strategy

Business Mergers and Takeovers

- Firms either merge with or acquire other firms for a number of reasons.

- 1960s and 1970s, Gulf & Western, and I.T.T built themselves into conglomerates by acquiring firms in other lines of business.

- 1980s, firms such as time, Beatrice, and R.J.R Nabisco were acquired by other firms,

- Their own management or wealthy raiders who saw potential value from restructuring or breaking up these firms.

- Firms have also acquired or merged with other firms to gain the benefits of synergy,

- either in the form of higher growth, as in Disney's acquisition of Capital Cities, or lower costs.

Objectives

- Explain how widely used is synergy as a motive for acquisitions? What are the different forms synergies can take? How should synergy be valued?

- Explain if diversification is a good motive for acquisition.

- Explain what is the value of controlling a firm? How should the value of control be estimated?

- Explain what the empirical evidence tells us about the prices paid in acquisitions and the motives for such acquisitions?

Classification of Acquisitions

- ☐ Number of ways in which a firms deal can go

- ☐ Merger

- The boards of directors of two firms will agree to combine

- Seek stockholder approval for the combination

- Least 50% of the shareholders of the target

- Bidding firm have to agree to the merger

- Purchase of assets, a firm acquires it through formal vote by the shareholders

- For a tender office

- A firm offers to buy the outstanding stock of the other firm at a specific price and communicates this of fer in advertisements and mailings to stockholders.

- Passes the incumbent management and board of directors of the firm.

- Tender offers are used to carry out hostile takeovers.

- Tender Offer: This is an offer to buy the existing shares of a company at a specified price, with the intent of taking over the company.

Another difference between mergers and tender offers is that, in a merger, the acquired firm often ceases to exist as a separate entity after the acquisition.

In a tender offer, the acquired firm will continue to exist as long as there are minority stockholders who refuse to tender. From a practical standpoint, however, most tender offers eventually become mergers, if the acquiring firm is successful in gaining control of the target firm.

□ Motives Behind Acquisition

- ✿ Undervaluation - that firms that are undervalued by financial markets, relative to their true value, will be targeted for acquisition by those who recognize this anomaly.

- Synergy, which refers to the potential additional value from combining two firms, either from operational or financial sources?

- Market for corporate control, in which poorly managed firms are taken over and restructured by the new owners, who lay claim to the additional value.

- Managerial self interest and hubris are the primary, though unstated, reasons for many takeovers.

Synergy: This is the increase in value from combining two firms into one entity; that is, it is the difference in value between the combined firm and the sum of the individual firm values.

Historical Perspective of Mergers and Acquisition

- ☐ Merger and takeover activity in the United States has occurred in waves, with difference motives behind each wave.

- The first wave occurred in the early part of this century, when companies like U.S. Steel and Standard Oil I were created by acquiring firms within an industry with the explicit objective of dominating these industries and creating monopolies.

- ☐ The second wave coincided with the bull market of the 1920s, at which time firms again embarked on acquisitions as a way of extending their reach into new markets and expanding market share.

- ☐ General Foods and Allied Chemical came into being.

- ☐ The third wave occurred in the 1960s and 1970s, when firms such as Gulf and Western focused on acquiring firms were acquired primarily with the intent of restricting the firms.

In some cases, the acquisitions were financed heavily with debt and were initiated by the managers of the firms being acquired.

- ☐ The acquisition of R.J.R Nabisco, but wanted toward the end of the decade, as deals became pricier and it became more difficult to find willing lenders.

Interestingly, merger activity seems to increase in years in which the stock market does well, which is counter to what one would expect if the primary motive for acquisitions were undervaluation.

- ☐ Mergers involved oil companies, whereas the focus shifted to food and tobacco companies in the latter half of the decade and shifted again to media and financial service firms in the early 1990s.

Merger

Merger refers to consolidation of two or more companies to form an all-new entity with a new name. Merger assists the companies in uniting their strengths, resources and weaknesses. Merger leads to a reduction in trade barriers and competition.

Types of Merger

Horizontal

· Vertical

• Congeneric

• Reverse

Conglomerate v/s

Acquisitions

Acquisition is the purchase of an entity by another entity. This can be done either by acquiring ownership over 51% of its share capital or by taking over the assets of the company. The acquiring company is more influential in terms of structure, operations and size as compared to the target company.

Types of Acquisition

• Hostile

• Friendly

• Buyout

Image summary: A diagram illustrating the difference between a merger and an acquisition. In a merger, two separate entities, Company A and Company B, combine to form a single new entity, Company C. In an acquisition, Company A takes ownership of Company B, resulting in both companies being owned by Company A. The diagram highlights that a merger creates a new combined organization, while an acquisition results in one company controlling the other.

Empirical Evidence on Value Effects of Takeovers

☐ Substantial empirical evidence exists about the effects of takeovers on the value of both the target and bidder firms.

☐ The evidence indicates that the stockholders of target firms are the clear winners in takeovers – they earn significant excess returns not only around the announcement of the acquisitions but also in the weeks leading up to it.

Jensen and Ruback (1983) reviewed 13 studies that look at abnormal returns around holders in successful tender offers and 20% to target stockholders in successful mergers. Jarrell, Brickley, and Netter (1988) reviewed the results of 663 tender offers made the 1970s, and 30% between 1980 and 1985.

☐ Many of the studies report a run-up in the stock price prior to the takeover announcement; this finding suggests either a very perceptive financial market or leaked information above prospective deals.

Some attempts at takeovers fail, either because the bidding firm withdraws the offer or the target firm fights it off. Bradley, Desai, and Kim (1983) analyzed the effects of takeover failures on target firms are taken over within 60 days of the first takeover failing, earning significant abnormal returns (50% to 66%).

The effect of takeover announcements on bidder firm stock prices is not as clear cut. Jensen and Ruback report abnormal returns of 4% for bidding firm stockholders around tender offers and no abnormal returns around mergers. Jarrell, Brickley, and Netter, in their examination of tender offers from 1962 to 1985, note a decline in abnormal returns to bidding firm stockholders from 4.4% in the 1960s to 2% in the 1970s to -1% in the 1980s. Other studies around the announcement of takeovers; thus, shareholders may be skeptical about the perceived value of the takeover in a significant number of cases.

When an attempt at a takeover fails, Bradley, Desai, and Kim (1983) report negative abnormal returns of 5% to bidding firm stockholders around the announcement of the failure. When the existence of a rival bidder in figured in, the studies indicate significant negative abnormal returns (of approximately 8%) for bidder firm stockholders who lose out a rival bidder within 180 trading days of the announcement and no abnormal returns when no rival bidder exists.

Conclusion

Valuing a firm for a takeover is not an easy task. In addition to all the complexities associated with standard valuation, other roadblocks have to be negotiated before arriving at a final answer. The first is the effect of synergy, assuming it exists and can be described in sufficient detail to be built into the valuation.

The second is the impact on value of management changes the firm: the potential increase in value is much larger for badly managed firms. The third is the effect on value of managed firms. The third is the effect on value of additional leverage that may be taken on, to finance a takeover.

Summary

The entire question of valuation in takeovers is framed by the strong biases in the process to justify decisions that have already been made. The use of multiples and comparable firms provides plenty of opportunity for biases to enter the process. Finally analysts doing a valuation for a takeover do not have the luxury of drawing on the law of large numbers to bail them out, unlike portfolio managers, who can choose to create portfolios of undervalued firms and hope that, on average, they come out ahead.

Nnanna F. E. Adaptation from A.C.C 405, Corporate Finance, (First Edition), Lagos: Noun Publishers

Ross S.A et al, Fundamental of Corporate Finance, U.S.A: McGraw-Hill Inc. Damodaram A., Corporate Finance: Theory and Practice, U.S.A: John Wiley and Sons Inc.

google dot com dot ng U.R.L Nnamdi Azikiwe University

Course Title

Financial Management And Strategy

1.0 Introduction

2.0 Objectives

3.0 Main Content

3.1 Trade offs

3.2 Determinates of Dividend Policy

3.3 Framework for Analyzing Dividend Policy

Contents

3.3.1 How much can a firm pay out or return Shareholders?

3.3.2 What kind of Projects Does the firms have?

3.3.3 Poor Projects and Low Pay Out

3.3.4 Good Projects and Low Pay Out

3.3.5 Poor Projects and High Pay Out

3.3.6 Good Projects and High Pay Out

4.0 Conclusion

5.0 Summary

Determination and Implications of Dividend Policy

Introduction to Dividend Policy

Image summary: A diagram showing a winding path marked by five numbered flags, each representing a sequential step in understanding dividend policy. The steps progress from definition and purpose, through theories, influencing factors, and policy types, to the final impact on shareholders. The figure outlines a structured learning path for analyzing corporate dividend strategies.

Dividend Policy Theories

Impact on Shareholders - Frame work that considers how cash generated from projects should be returned to shareholders and the form this cash should take

Objectives

- Explain when a firm should be pressured to increase its payout to stock holders and how such a firm should defend it.

- Explain when a firm be pressured to reduce its payouts to stockholders and what are the consequences of excessive dividends.

- Explain what types of firms have the most flexibility in setting dividend policy?

- Explain how firms should measure their dividend policies against comparable firms.

Determinants of Dividend Policy

Factors Affecting Dividend Policy

Type of Industries

Shareholder's Expectations

Changes in Govt. Policies

Liquidity

Repayment of Debt Ownership Structure

Leverage

Profitability

Inflation Age of Corporation

Future Financial Requirements

Taxation Policy

Legal Rules Extent of Share Distribution

Business Cycles

Trends in Profit

Control Objectives eFinanceManagement dot com Factors to consider about

Dividend Policy

Image summary: A photograph showing a set of metallic surgical or dental instruments arranged on a white cloth surface within a circular frame. This is a descriptive image of medical tools, with no data or analytical result to report.

Dividend Policy Factors

Profitability

Only profitable companies will declare dividends.

Dividend trends in the industry

To retain their shareholders, companies might match the dividend trends that exist in their industry.

Property dividends

These dividends include 'giving shares of a subsidiary company as dividends.

Stock dividends

A company can issue less than one-fourth of its previously issued stock in stock dividends.

Image summary: A circular graphic depicting a hand placing a coin onto a small stack of coins. It is a conceptual illustration representing the act of saving or accumulating wealth.

Image summary: A circular icon depicting a stylized, white, modern sports car viewed from a high angle against a solid orange background. It serves as a visual graphic or logo representing a vehicle.

Types of Dividends Growth plans and availability of funds

A company may keep its profits if it intends to reinvest them to grow.

Dividend payment history

A company with a history of paying dividends keeps its dividend amount stable.

～

Cash dividends

The business pays its owners a certain sum per share as cash dividends.

Image summary: A stylized collage featuring a person in a suit with a laptop screen replacing their head, set against a circular background with faint graphical patterns. This is an illustrative image intended to convey a concept related to digital identity or technology, with no data to report.

Scrip dividends

When there aren't enough dividends, a corporation will issue a promissory note to its stockholders.

Dividend

A Dividend is distribution of part of the earnings of the company to its equity shareholders. The board of directors of the company decides dividend. It can be in percentage or amount form.

1. Cash Dividend

2. Bonus Share

3. Share Repurchase

4. Property Dividend

5. Scrip Dividend

6. Liquidating Dividend

Types of Dividend

Most commonly used type of dividend

Issued when low operating cash

- Buyback of own shares by the company

Payment made in form of assets

- Promissory note to pay dividend later

- Return of original capital as dividend

Advantages

Investor's preference for stable dividend receipt

Bird in Hand Fallacy

· Stability

Benefits without selling

Temporary Excess Cash

• Information Signalling

Paid in cash per share terms

Shareholders receives additional shares

Reduces the no. of shares outstanding

Value of asset restated at time of payment

Used when there is fund crunch

Seen as a sign of closing down of company

Disadvantages

Clientele Effect – Loss of old clientele, if unable to pay dividend for certain period

• Decreased Retained Earnings

• Limits company's growth as it reduces the usable cash

Logistics—Lot of record keeping

eFinanceManagement. com

Image summary: A diagram depicting the three primary factors influencing dividend decisions: investment opportunities, macroeconomic factors, and earning stability. The visual highlights these as the core considerations for businesses when determining dividend policies.

Trade-Offs

Definition

A trade-off refers to a situation in which gaining one benefit requires sacrificing another. It highlights the balancing act of choices and compromises made when multiple factors are at play. Trade-offs often

Example

Quantity versus Quality

(quantity) and ensuring that what is produced meets high standards

(quality). Often, increasing the quantity of production can compromise the quality, and vice versa.

Image summary: A diagram showing a stick figure standing at the base of two diverging arrows, one pointing upward and one to the right, labeled with the word Tradeoffs. The image illustrates the concept of making a choice between different paths or outcomes, emphasizing the necessity of selecting one direction over another.

Tradeoffs

Trade-off versus opportunity cost

Choosing one option over another

• Represents the decision/choice

• Defines which path the company has taken

Both

• Require evaluation and comparison of options

• Arise due to limited resources

• Fundamental concepts in strategic planning

Opportunity cost

The value of the best alternative

• A consequence of making a trade-off

• A measurement or quantification of the forgone benefit

Image summary: An infographic defining paid-in capital as money received from issuing shares in the primary market. It provides two formulas for calculation, summing par value with additional paid-in capital or adjusting stockholders' equity by subtracting retained earnings and adding treasury stock, and lists five corporate activities, such as issuing common or preferred stock and share buybacks, that impact these calculations.

Image summary: A simple icon featuring a white bar chart with an upward-trending arrow placed inside a blue oval. It is a graphic symbol representing growth or positive performance, with no data or analytical result to report.

Real Cash Dividends

Invest in proven Nigerian companies that reward shareholders with consistent cash payouts.

Financial Strength & Stability

Explore companies with strong fundamentals, competitive moats, and resilient business models.

Build Passive Income

Learn how to grow your wealth through dividends, compounding, and smart reinvestment strategies.

Expert Insights & Strategies

Get practical investment tips, risk management guides, and step-by-step actions to get started.

Top Nigerian Dividend Stocks in 2026

Companies Paying Real Cash to Shareholders & How to Build Passive Income

Discover 10 top dividend-paying stocks on the Nigerian Exchange N.G.X with strong financials, consistent payouts, and long-term growth potential. Learn proven strategies to build a diversified dividend portfolio and create sustainable passive income in Nigeria.

Top 10

Dividend Stocks

Real Cash Payouts

Image summary: A logo consisting of a dark blue vertical oval shape divided by white lines into three distinct segments, resembling a stylized letter G. This is a graphic design logo with no data or analytical result to report.

Diversified

Sectors

Image summary: A simple bar chart icon showing four vertical bars of increasing height, overlaid with an upward-pointing arrow. The image represents the concept of growth or positive performance.

Long term Wealth

Smart Risk Management

Image summary: A diagram illustrating the determinants, forms, and outcomes of corporate payout policy. The framework shows that payout policies are influenced by various internal and external factors such as financial standing, market value, company size, and economic conditions, which then dictate the chosen form of payout, such as dividends or share repurchases. These policies ultimately impact the investment attractiveness of the company through participation in net profit and capital gains. The takeaway is that payout policy is a multifaceted decision process driven by diverse corporate and market factors that directly influence investor value.

Table summary: Communication cadence for project management, detailing the purpose, medium, frequency, and audience for five key activities. The Kickoff meeting is a one-off event for the project team and stakeholders to align on objectives. Weekly Project team meetings occur every Monday at 9 A.M. in-person, followed by email Check-ins for sponsors and stakeholders. Monthly Project status meetings are held via video conference to update leadership. Finally, a one-off UX design review is conducted in-person after the initial design is complete to gather feedback from the project sponsor.

Figure 1 summary: A diagram illustrating Porter's Five Forces model, which places competitive rivalry within an industry at the center, surrounded by four external pressures: the threat of new entrants, the bargaining power of suppliers, the bargaining power of customers, and the threat of substitute products. Arrows indicate that these four forces interact with and influence the central competitive rivalry. The diagram serves as a framework to analyze the competitive intensity and attractiveness of an industry.

Porter's Five Forces

Understanding Dividend Policy

Image summary: A conceptual diagram showing five independent variables—Profitability, Size, Tax, Investment Opportunities, and Life Cycle Stage—all pointing toward a single dependent variable, the Dividend Payout Ratio. The structure illustrates that these five factors are hypothesized to influence a company's dividend payout policy.

Dividend Theories

Dividend Theories suggest how value of company is affected by decision of distributing profits as dividends by management

Figure 2 summary: A circular diagram mapping eight core components of corporate dividend policy, including objectives, payment methods, stability, reinvestment plans, taxation, shareholder value, capital structure, and market signals. The structure illustrates the interconnected nature of these financial considerations in shaping a company's dividend strategy.

Types of Dividend Theories

Dividend Relevance Theories

This theory believes decision of giving away dividends does have an impact on value of company

Traditional View

Given by D. L. Dodd & B. Graham

○ They say shareholders attach high importance to liberal dividends in present

○ Giving lesser importance to capital gains that may arise from investment in future

Higher dividends in present will result in higher market value for Co. & vice-versa

Walter Model

Developed by James Walter

Two instances when dividend policy is relevant & can impact value of Co.

O R.O.I> Cost of Capital

0 R.O.I less than Cost of Capital

Assumptions

All-equity capital structure

No external source of finance

Co.'s infinite life R.O.I is constant

Equation

P = M (D + E divided by 3

• P = Market price per share

• M= Multiplier

• D= Dividends per share

• E = Earnings per share

Gordon Model

Given by Myron Gordon

○ He says, shareholders are averse to risk

○ Hence, they prefer to earn dividends in present rather than wait for higher capital gains in future

Dividend Irrelevance Theories

This theory believes decision of imparting dividends is irrelevant to deciding value of company

Modigliani and Miller M.M Approach

Given by Merton Miller and Franco Modigliani

○ He says value of Co. depends upon its basic power of earning & its asset investment policy

Assumption

○ Perfect capital market

Rational investors

o Absence of transaction costs, taxes, & floatation costs

○ No individual has power to influence capital market

o Investment policy and dividend policy are independent

○ Certainty of investment opportunities & future profits

Framework for Analysing Dividend Policy

How much cash is available to be paid out as dividends, after meeting capital expenditure and working capital needs to sustain future growth, and how much of this cash is paid out to stockholders?

How good are the projects that are available to the firm?

In general, firms that have good projects will have much more leeway on dividend policy, since stockholders will expect that the cash accumulated in the fi rm will be invested in these projects and eventually earn high returns.

☐ How much can a firm pay out or return Shareholders

- Net Income and convert it to a cash flow

- Capital expenditures are subtracted why the represent a cash outflow, Depreciation & noncash charge

- Difference between capital expenditures and depreciation is referred to as net capital expenditures.

- Function of the growth characteristics of the firm

- Increases in working capital drain a firm's cash flows.

- Decreases in working capital increase the cash flows available to equity investors, firms that are growing fast, in industries with high working capital.

- Because we are interested in the cash – flow effects.

☐ What kind of Projects Does the firms have?

- The alternative to returning cash to stockholders is reinvesting the funds back into the firm. Consequently, a firm's investment opportunities provide another dimension for analyzing dividend policy. Other things remaining equal, a firm with better projects typically has more flexibility in setting dividend poly and defending it against stockholders.

Poor Projects and Low Pay Out

- Consequences of paying out much less in dividends than a firm has available in cash flows, while facing poor investment opportunities.

google dot com dot ng U.R.L

google dot com dot ng U.R.L What kind of Projects Does the firms have&sca esv=

google dot com dot ng U.R.L

google dot com dot ng U.R.L

You have reached the end of the document.