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Introduction

This project report is based on financial management , financial management is based on how to manage the funds in such a manner  to achieve the objectives of the organization. This is directly related to the top management of an organization, and it is the planning , organising, directing and controlling of the financial  activities and from these hows to utilize the funds from the resources. In this report we discuss about a dividend and their theories and explain  that theories are relevant and irrelevant with academic research. And also discuss about merger and acquisition fundamental role in business. And evaluate that merger and acquisition will maximise the shareholder wealth.

Part A. Explain Dividend relevance theory and dividend irrelevance theory?

Dividend policy which affects the value of firm can be considered as relevant. If there is positive relationship between a dividend and market value and preference of current dividend is been suggested by Walter and Gordon (Linawati and Halim, 2017). Majorly investors are risk averse and they usually prefer a current dividend which is giving less importance to capital gain and dividends of future. So in this series- Walter Model and Gordon Model

Walter Model : James E. Walter says that value of enterprise is always affected by type of dividend policy. Relationship between cost of capital and internal rate of return plays major key role while determining dividend policy which helps in maximizing shareholders wealth (Vogiatzi, 2015). Assumptions of Walter model are,

  • Internal financing has been practised in the context of firm's investments, which are usually with retained earning, external financing is not used i.e. new debt or equity are not issued for same (Mattli and Dietz, 2014).
  • For all investment decisions business risk remains constant and technically internal rate of return and cost of capital of the firm are same (never change).
  • Earnings and dividend of the firm in the beginning never change. EPS and DPS are used in the model but the assumption is that they remain constant while value is been determined.
  • Margin or earning which is made by company is reinvested internally or may be distributed as dividends.
  • The company has long and infinite life (Mellor and Shilling, 2016).

Formula for determining market price per share can be denoted as:

P=D/K+r(E-D)/K/K

P is market price per share, D is dividend per share, E is earning per share, r is internal rate of return and K is cost of capital. This equation gives indication that MPS of firm's share is aggregate of present values of infinite flow of gains from retained earning on investments and dividends.

As it is stated above that optimum dividend policy depending on the relationship between IRR and Cost of capital. If R is greater than K, entire earnings should be retained and if K is greater than R then all earnings should be distributed to the shareholders. The main thinking about the Walter model when R is greater than K, then organization is able to make more return as compared to shareholders from retained earnings (Masubuchi 2013). Growth firms have K smaller than R. The main assumption is to have enough profitable opportunities. These firms can earn returns very easily which is always more than what shareholders can do on their own. Normal firms have R and K equal. Usually these firms gain same return as compared to shareholders. The price per share is not been influenced by dividend policy, so there is absence of payout ratio for a normal organization (Baker and Riddick, 2013). Declining firms have lower R as compared to K, Firm's return is less than compared to shareholder's investment. There is no sense for retaining the earning. So for maximizing the price per share entire earnings should be distributed among shareholders.

Gordon Model: It states that current dividend plays major role in determining firm's value. The most famous model for calculating the company's market value by using the dividend policy. Assumptions of Gordon model can be,

  • In the capital structure there is no proportion of debt, the company should be form of equity only i.e. it should be considered as an equity firm (Brigham and Ehrhardt, 2013).
  • All the investments of the company should be funded by internal financing i.e. retained earnings, external financing is not required.
  • Internal rate of return (r) should be constant and diminishing marginal efficiency of the investment should be ignored.
  • Cost of capital (K) must be constant which implies that investments related to business risk be same (Cao and Han, 2016).
  • Gordon model says that a firm should have perpetual earning or repetitively ernings.
  • In taxation corporate taxes are not existed in this model.
  • In this model retention ratio is constant, if it is decision taken by the company. Growth rate (g) = b*r, by this logic growth rate should be constant.
  • K is greater than G which replicates cost of capital is greater than growth rate and this is essential for getting the value of company's share (Kale and Singh, 2017).

Formula for determining market price per share can be d