Fill This Form To Receive Instant Help
Fill This Form To Receive Instant Help
Homework answers / question archive / Question 1: Analyze the dividend policy of RIL for shareholders’ wealth maximization and advise on an optimal dividend policy to ensure shareholders’ wealth is maximized
Question 1: Analyze the dividend policy of RIL for shareholders’ wealth maximization and advise on an optimal dividend policy to ensure shareholders’ wealth is maximized. Please discuss following questions in your response:
- What type of dividend policy has RIL been following? (Constant payout, constant dividend per share, or long-run residual policy?)
The constant payout approach is a dividend strategy in which a company determines a level of dividend payout and applies this to net income. Here, a certain percentage of profits is paid to the shareholders every year. But when profits decline, shareholders may become concerned, as the constant dividend payouts may affect the stock price. Companies prefer the constant payout policy because it indicates their ability to pay dividends. Firms “smooth” their dividend payments over time to try to maintain a stable dividend payout ratio.
The long-run residual policy is intended to build trust in shareholders by offering to pay a regular, or even increasing, dividend; hence it signals to shareholders that the company looks out for their financial well-being. Companies first anticipate the applicable factors on the dividend size for a given period, typically five years, and then decide on the payout ratio. Dividends over the years may vary, as long as the target payout ratio is in line with the absolute income over the same period. This policy is most suitable for companies experiencing fluctuated earnings.
In the constant dividend per share strategy, companies pay a steady dividend per share regardless of their earnings per share, i.e., any change in their net profit will not influence the dividend paid to shareholders. Companies that have minimal development potential and are expecting stable earnings in the future adopt this type of policy.
- Does RIL look after its shareholder’ interests? How?
- What factors should a company consider when planning its investment budget?
1) Reliance has been consistently declaring dividend every year. However the rate of final dividend for previous five years is as follows:-
Year Rate
5( being latest) 65%
4 65%
3 60%
2 110%
1(being earliest) 100%
From this it is clearly evident that RIL doesnot follow a constant payout or constant dividend per share policy. It follows a long run residual policy of regular or even increasing dividends.
It shows that for RIL primary focus is on investment rather than dividend ( dividend is treated as passive decision variable). Thus RIL stock price will rely more on investment projects funded through its retained earnings which will increase value of firm. This is evident practically also as Reliance JIO is heavily investing in 4G and now 5G infrastructure projects. Wealth maximisation is eventually reflected in the increasing share price of RIL . Thus RIL residual dividend policy is optimal for shareholders wealth maximisation.
2) As explained in 1) above RIL through its residual dividend policy is ensuring that a consistent dividend is paid every year. In addition to it it is also suitably funding its investment through retained earnings for all capital expansion projects.( FYI reliance is a net debt free company) This provides investor twin return in form of stock appreciation and consistent dividend. As such reliance is looking after its shareholder's interest pretty well.
3) Factors to be considered before planning investment budget :-
a) Source of Funding such investment eg. Debt or Equity
b) Cost of Capital for funding such investment and its impact for eg. Assessing Debt service coverage in case of debt funding and its impact on statement of profit or loss.
c) Payback period for such investment i.e. when the original cost of investment will be recovered.
d) Assessing Cash flows and Fund flow position before and after such investment.
e) Net present value and Sensitivity analysis for such investment factoring in various available alternatives and scenarios.
