BUSF_A01.qxd

Chapter 12 • The dividend decision

From equation (A12.5) we can see that the value of the business at time tis depend-

ent upon anticipated dividends, the value at the end of the period and the value of any

new shares issued. However, the quantity of new shares that it is necessary to issue is,

in turn, dependent on the size of dividends paid:

mtP(t+1)=It−(Xt−Dt) (A12.7)

where Itis the real investment and Xtthe operating cash flow surplus during the

period. That is to say, the value of the finance that must be raised from new share

issues is the excess of the funds invested over the operating cash flow surplus after

dividends have been paid. In other words, the value of the new issues depends on the

extent to which new investment exceeds retained profit.

Substituting equation (A12.7) into equation (A12.5) for mtP(t+1)gives:

Vt=

The Dtterms cancel each other out to give:

Vt=

Thus Vtis independent of the amount of dividend paid during the forthcoming

period, but depends on the anticipated value of the business at the end of the period,

the anticipated level of investment and cash flow surplus.

Dividends can be at any level. Any cash deficiency caused by dividends being paid

in excess of operating cash flows can be made up through capital issues of new equity.

The assumptions made and their validity are discussed in the chapter.

V(t+1)−It+Xt

1 +rt

Dt+V(t+1)−It+Xt−Dt

1 +rt