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250 Corporate Finance BRILLIANT’S

with the firm's risk. Thus, the present value of grYo n[ad{V©V hmoVr h¡Ÿ& AV:, \$_© H$s BZH$_ H$s àoOoÝQ>
the firm's income moves inversely with the cost d¡ë`y, H$m°ñQ> Am°\$ H¡${nQ>c Ho$ gmW {dn[aV ê$n go _yd
of capital. By assuming that cost of capital rate H$aVr h¡Ÿ& H$m°ñQ> Am°\$ H¡${nQ>c K H$mo pñWa _mZH$a dmëQ>g©
K is constant, Walter's model abstracts from _m°S>c Zo \$_© H$s d¡ë`y na {añH$ Ho$ à^md H$mo ZOaA§XmO
the effect of risk on the value of the firm. {H$`mŸ&

(B) Gordon's Model (B) Jm°S>©Z H$m _m°S>c
Another popular model relating to the \$_© H$s _mH}$Q> d¡ë`y Ed§ {S>{dS>oÝS> nm°{cgr go gå~pÝYV
market value of the firm to dividend policy is Xygam cmoH${à` _m°S>c _¡am°Z Jm°S>©Z Ûmam {dH${gV {H$`m
developed by Myron Gordon. This model J`mŸ& `h _m°S>c _mZVm h¡ {H$ EH$ \$_© H$s {S>{dS>oÝS>
opines that dividend policy of a firm affects its
value and is based on the following nm°{cgr CgH$s d¡ë`y H$mo à^m{dV H$aVr h¡Ÿ& `h {ZåZ{c{IV
assumptions: _mÝ`VmAm| na AmYm[aV h¡:
(i) The firm is an all equity firm. No external (i) \$_© EH$ nyU©V: B{ŠdQ>r \$_© h¡Ÿ& EŠgQ>Z©c \$m`ZopÝg¨J
financing is used and investment progra- H$m Cn`moJ Zht {H$`m OmVm h¡ Ed§ BZdoñQ>_oÝQ> àmoJ«måg
mmes are financed exclusively by retained Ho$dc [aQ>oÝS> A{Zª½g Ûmam \$m`ZoÝñS> {H$E OmVo h¢Ÿ&
earnings. NPP
(ii) The internal rate of return (r) and cost of (ii) BÝQ>aZc aoQ> Am°\$ [aQ>Z© (r) Ed§ H$m°ñQ> Am°\$ H¡${nQ>c
capital (K) are constant. (K) pñWa h¡Ÿ&
(iii)The firm has perpetual life. (iii)\$_© H$s Am`w XrK© h¡Ÿ&
(iv)The retention ratio, once decided upon, is (iv)EH$ ~ma {ZYm©[aV hmoZo na [aQ>oÝeZ aoemo pñWa
constant. ahVm h¡Ÿ&
Gordon’s model, like Walter's model, dmëQ>a _m°S>c Ho$ g_mZ hr Jm°S>©Z _m°S>c ^r `h
contends that dividend policy of the firm is _mZVm h¡ {H$ \$_© H$s {S>{dS>oÝS> nm°{cgr àmg§{JH$ h¡ VWm
relevant and investors put a positive premium BZdoñQ>g© {S>{dS>oÝS> H$s H$aÝQ> BZH$_ H$mo àmW{_H$Vm XoVo
on current income dividends. Gordon argues
that dividend policy affects the value of shares h¢Ÿ& Jm°S>©Z Zo VH©$ {X`m {H$ {S>{dS>oÝS> nm°{cgr \$_© H$s d¡ë`y
even in a situation in which the return on H$mo Cg pñW{V _| ^r à^m{dV H$aoJr {Og_| EH$ \$_© Ho$
investment of a firm is equal to the required BZdoñQ>_oÝQ> na [aQ>Z© CgHo$ H¡${nQ>cmBOoeZ aoQ> ~am~a
capitalisation rate (r = K ). hmoŸ(r = K )&
e e
The investors are rational. They want to BZdoñQ>g© {ddoH$s hmoVo h¢Ÿ& do [añH$ go ~MZm MmhVo
avoid risk. The risk refers to the possibility of h¢Ÿ& [añH$, BZdoñQ>_oÝQ> na [aQ>Z© àmßV Z H$aZo H$s g§^mdZm
not getting a return on investment. The go gå~pÝYV h¡Ÿ& H$aÝQ> {S>{dS>oÝS> H$m ^wJVmZ [añH$ H$s
payment of current dividend completely {H$gr ^r g§^mdZm H$mo nyU©V: g_má H$a XoVm h¡Ÿ& hmcm§{H$,
removes any chance of risk. However, if the firm
retains the earnings, the investors can expect to `{X \$_© A{Zª½g H$mo gwa{jV aIVr h¡ Vmo BZdoñQ>g© ^{dî`
get a dividend in future. The future dividend is _| {S>{dS>oÝS> àmá H$aZo H$m AZw_mZ cJm gH$Vo h¢Ÿ& â`yMa
uncertain both regarding the amount and {S>{dS>oÝS> am{e Ed§ g_` XmoZm| Ho$ g§~§Y _| A{ZpíMV hmoVm
timing. The rational investors can be expected h¡Ÿ& {ddoH$s BZdoñQ>g© H$aÝQ> {S>{dS>oÝS> H$mo ng§X H$a gH$Vo
to prefer current dividend. In other words, they
would place less importance to the future h¢Ÿ& AÝ` eãXm| _|, do H$aÝQ> {S>{dS>oÝS> H$s VwcZm _| â`yMa
dividend as compared to current dividend. {S>{dS>oÝS> H$mo H$_ _hËd XoVo h¢Ÿ&