Dividend Retention and Dividend Growth

Dividend Retention and Dividend Growth

Dividend retention and dividend Growth relationship was explained by the Gordon by a formula i.e. Growth = Retention x rate of investment. it means that with more retention of dividend , growth of dividend may be accelerated. This has been explained with an example,

Dividend Retention and Dividend Growth Example

B has profitable operation and is interested in future growth of dividend. The cost of investment of C & Co is 13%. There are two suggestions that to retain 40% and 60% of its income, which option should be chosen for higher growth rate of dividend.

Solution

Gordon Growth of Dividend = Retained Earning x Return, this formula can be expressed

G=Br

Where,

G= Dividend Growth Rate

B= Retained earning

r= Rate of return on equity

1.     Dividend Retention 40%

= 40% x 13%

=5.2%

2.    Dividend Growth 60%

= 60% x 13%

=7.8%

Above results clearly shows that growth of dividend increases by retaining more earning.

Gordon Growth Payout Example

Gordon Growth Payout Example

C Company is making huge profit and board of director has decided to pay 70% of its earning. The cost of investment of C & Co is 11%. Calculate the Gordon Growth of Dividend.

Solution

Gordon Growth of Dividend = Retained Earning x Return, this formula can be expressed

G=Br

Where,

G= Dividend Growth Rate

B= Retained earning

r= Rate of return on equity

In this example we are not given dividend retained %, therefore in first place we would calculate the Dividend retained from dividend payout % i.e. (Divided retained = 1- Dividend paid).

1.    Retained Divided

Dividend Retained = (1- Dividend paid)

Dividend Retained = (1- 70%)

Dividend Retained = 30%

2.    Dividend Growth

= 30% x 11%

=3.3%

Gordon Growth Dividend Model Example

Gordon Growth Dividend Model Example

XYZ Company board of director has planned to retain 70% of earning. The cost of equity in the market is 16%. Calculate the Gordon Growth of Dividend.

Solution

Gordon Growth of Dividend = Retained Earning x Return, this formula can be expressed

G=Br

Where,

G= Dividend Growth Rate

B= Retained earning

r= Rate of return on equity

By putting value in above formula, we can solve the above Example

= 70% x 16%

=11.2%

Gordon Dividend Growth Model Example

Gordon Dividend Growth Model Example

ABC Company director decide to retain 60% of earning. The cost of equity is 15% in the market. Calculate the Gordon Dividend Growth for ABC Co.

Solution

Gordon Dividend Growth formula = Retained Earning x Return, this formula can be expressed

G=Br

Where,

G= Dividend Growth Rate

B= Retained earning

r= Rate of return on equity

By putting value in above formula, we can solve the above Example

= 60% x 15%

= 9%

Gordon Growth Model Example

Gordon Growth Model Example

A company retains 30% of earning and return on equity investment is 9%. What is dividend growth Rate of dividend?

Solution

Gordon Dividend Growth formula = Retained Earning x Return, this formula can be expressed

G=Br

Where,

G= Dividend Growth Rate

B= Retained earning

r= Rate of return on equity

By putting value in above formula, we can solve the above Example

= 30% x 9%

= 2.7%

Agency Theory

Agency Theory

1.    Separation of Ownership & Management

Under agency theory management & ownership are two different aspect of organization. Business is managed by manager hired by the owners. Manager acts on behalf of the owner as agent.

2.    Management act in Best interest

Under agency theory, it is believed that manager will work in the best interest of ownership. Therefore a formal hired by the owners to manage the business. It is an ideal situation or case of agency theory.

3.    Management Self Interest

Agency theory recognizes the fact, that management may have their self interest like increase in salary and bonuses. Therefore it is not practical that manager will only focuses on the interest of owners.

4.    Manager & Owner Conflict

Agency theory recognizes that Manager Interest and owner interest conflict with each other. Management may look into short term profit, while ownership is more interested in long term growth. Manager is ready to take risky decision, while owner would love to minimize the risk.

5.    Manager Create Cost

Agency theory explains that Management create number of costs for the ownership. For example an increase in salary is cost for the ownership, as it will reduce the ownership wealth. It is important to remember that any cost of expense is a hit on ownership wealth.

6.    Balance

Agency theory explains a balance between management and ownership. Management should look to ownership interest and ownership should also give due consideration to self interest of management.

Different Organizational Objectives

Different Organizational Objectives

Different organizations have different objectives. In other words we can say that different organizations are created for different objectives. Every organization is created for an objective.

1.    Commercial Organization

Commercial organization has objective to maximize profit. This is regarded as primary objective. There are number of other objective, which basically support this primary objective.

2.    Public Organization Objective

Public organization is created to provide certain level of services to the society i.e. education and health facilities.

3.    No profit organization

Nonprofit organization objective is to achieve certain target in a selected area. Some people regard this as intervention.