Factors To Consider When Deciding Dividend Policy For A Listed Company

The price-earnings ratio is one of the common method of valuing a company. In this method, value of company is determined from the Price earnings ratio of the similarly quoted company (Brigham and Ehrhardt 2013). The calculation showing market value of company using the PE ratio is given below:

Table 1: Valuation using PE ratio

(Source: Created by Author)

Table 2: Valuation of shares using Dividend valuation method

(Source: created by Author)

The table above indicates the valuation of shares using the dividend valuation method. The expected return that is used in the formula has been calculated using the Capital assets pricing model.

Table 3: Valuation using Dividend model

The crucial analysis of all these methods of valuation style that is relevant for particular situations decreases the worth of the methodologies. Price Earnings Ratio is one of the most common tools for valuation technique in a business enterprise and this used by the investors while taking the investing decisions (Brigham 2014).

Limitations of Price earnings ratio are:

• When Inflation is high, price earnings ratio is inclined to be lesser. The picture of stock valuation is generally not clear at the time bear market.
• This has great chance of distortion and manipulation of the data regarding to earnings of a company.
• The undervaluation of a company is not always result of low price earnings ratio.
• A company might twist Price earnings ratio into a variety of ways of bookkeeping. This occurs for the reporting of lower earnings due to the tax returns (Petty et al.2015).

Limitations of Dividend valuation method:

• Dividend valuation method is not relevant for large shareholders as the person holds usually huge piece in the company. For them this way is not at all relevant condition for an investor and company.
• The assumption of taking the rate of growth of a nation is stagnant that is impractical as per the companies are concerned (Renz 2016).
• As per the above point, there are too many assumptions that make this impractical. The assumptions such as growth rate, tax rate and interest rates are constant.

Limitations of Discounted Cash flow method:

• Discounted Cash Flow method is inclined to time intensive procedure than any other ways of valuation and analysis.
• It is extremely responsive to forecasts/ assumptions generally taken by the person critically analysing the data (Finkler et al. 2016).
• If any businesses anticipation and potentials are altered then the fair value is modified as per the anticipations. Therefore, this technique of valuation is then a target that always move.
• Discounted Cash Flow engrosses anticipating the performance in future. When a business enterprise does not function with full transparency then it becomes extremely complicated.

Based on the above discussion it can be seen that all the methods have its own advantages and disadvantages. However, it can be said that the dividend valuation method is best suited for the purpose.

The benefits and limitations of different valuation techniques are discussed below.

Pay back period

The Benefits of Payback period are:

• This is simple to understand and used widely.
• This provides added significance on liquidity for taking assessment on the proposals of investment.
• This deals with threats. The payback period that is shortest may have fewer risk than compared to the longest payback period projects.
• The payback period in case of short term, we get an extra benefit of computing capital expenditure.
• The business that faces the acute problem of deficiency of liquidity then this facilitates superior project rankings that would result receiving of early money (McKinney 2015).

Losses of Payback Period:

• In the computation of payback period, the time value of money not acknowledged.
• Payback period pay no attention to the profitability and gives far more stress on liquidity.
• Only flow of cash is earlier than the payback period. This is considered. If flow of cash takes place after payback period then it is not considered.
• Benefits of Accounting Rate of Return are:
• Accounting Rate of Return is established around the information of accounting. Therefore, Accounting Rate of Return does not require to be determining by other special reports.
• Accounting Rate of Return is easy to understand
• Accounting Rate of Return is simpler to compute.
• This technique is established around the profit in accounting. Therefore, gauges the investments profits and its profitability’s.

Accounting rate of Return

The benefits are:

• In this method the investment appraisal calculation is easy;
• In this the profitability factor of the investment is recognised;

The Limitations of Accounting Rate of Return are:

• Accounting Rate of Return does not acknowledge the time value of money.
• Accounting Rate of Return, process pays no attention to the flow of cash from the venture.
• Accounting Rate of Return will not consider project’s terminal value (Attig et al.2016).  

Net present value

  The benefit of this technique are:

• This method takes into account time value of money;
• The NPV provides better decisions than any other discounted cash flow technique.

The limitation of this technique are:

• It is based on estimation and is subject to changes.
• It fails to takes into account the size of the project.

Internal rate of return

The benefit of this technique are:

• It is a simple method.
• It takes into account the time value of money.

The disadvantages or limitations are:

• In this method, it is assumed that the positive cash flows are reinvested in the project.
• It depends on various factors.
• The projects of different time period cannot be evaluated using the IRR method.

Reference

Attig, N., Boubakri, N., El Ghoul, S. and Guedhami, O., 2016. The global financial crisis, family control, and dividend policy. Financial Management, 45(2), pp.291-313.

Brigham, E.F. and Ehrhardt, M.C., 2013. Financial management: Theory & practice. Cengage Learning.

Brigham, E.F., 2014. Financial management theory and practice. Atlantic Publishers & Distri.

Finkler, S.A., Smith, D.L., Calabrese, T.D. and Purtell, R.M., 2016. Financial management for public, health, and not-for-profit organizations. CQ Press.

McKinney, J.B., 2015. Effective financial management in public and nonprofit agencies. ABC-CLIO.

Petty, J.W., Titman, S., Keown, A.J., Martin, P., Martin, J.D. and Burrow, M., 2015. Financial management: Principles and applications. Pearson Higher Education AU.

Renz, D.O., 2016. The Jossey-Bass handbook of nonprofit leadership and management. John Wiley & Sons.

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