Dividend Policy of British Petroleum Plc - Research Paper Example

Dividend Policy of British Petroleum Plc Introduction A capital structure is defined as a mix of permanent long term capital employed by enterprises to run their operations and to meet their long term project investment needs. There are two main sources available from which a firm can obtain finance. They are internal (retained earnings) and external (debts and equity). The retained earnings is also part of equity or share capital and, it is seen an investment in firm from the existing shareholders for which they will get more return in future. Eventually there are two main source of finance as equity and debt. Hence, the capital structure decisions are associated to adjustment of this mix of two variables namely debt and equity, in order to minimize average cost of capital and maximize the market value of firm. It is often seen that the mix of debt and equity varies across firms and industries depending on various factors such as type of industry, firm size, kind of assets employed by firm so on. Companies can pay cash to its shareholders in two basic ways. They can either pay dividends of can buy back the outstanding shares. Dividend is the cash paid to the shareholders from the net income of the company. There are many theories surrounding the payment of dividends in companies written by financial gurus like Walter, Graham Dodd, Miller and Modigliani and John Linter. Though the management and dividend theories form the base of dividend payout decisions, practical factors like companies internal and external environment also has an important role to play in deciding the appropriate dividend payout ratio. The paper analysis the dividend policy of BP plc based on the proposed models and on the company environment. The paper begins with the introduction of proposed dividend theories by various theorists then analyzing the company specific factors. Walter Model Walter model was given by Prof. James E Walter, who described a simple theory about how dividend can be used to maximize shareholders wealth. According to Walter, the PV of future streams of dividends is reflected in the current market price of the stock of the company. The model uses the following formula to calculate the share price of the company: P = (D + (E-D) r/k) / k, where price is the price of equity share, E is the EPS of the company, D is the dividend per share, r is the ROI and k is the cost of equity capital. According to the Walter model, the optimal payout ratio for a growth firm (r >k) is nil, the optimal payout ratio for a normal firm (r=k) is irrelevant and the optimal payout ratio for a declining firm (rk) is nil, the optimal payout ratio for a normal firm (r=k) is irrelevant and the optimal payout ratio for a declining firm (r Read More