Illustration 15.

Following are the details regarding three companies A Ltd., B Ltd and C Ltd.

A LTD. B LTD. C LTD.

r=15% r=5% r= 10%
Ke=10% Ke =10% Ke=10%
E=Rs. 8 E= Rs. 8 E=Rs. 8

Calculate the value of an equity share of each of these companies applying Walter’s formulae when
dividend payment ratio (D/P ratio) is (a) 25%, (b) 50% (c)75%.

What conclusions do you draw?

Solution :

VALUE OF AN EQUITY SHARE AS PER WALTER’S FORMULA

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

Ke Ke

A B C
(1)When D/P ratio is P= Rs. 110 P= Rs. 50 P=Rs. 80
25%
(2) When D/P ratio is P= Rs. 100 P=Rs 60 P=Rs. 80
50%
(3) When D/P ratio is P= Rs. 90 P=Rs. 70 P=Rs. 80
75%

Conclusion :A Ltd .This company is a growth firm.The rate of return is higher than the cost of capital(i.e.
r > Ke). It will be better to retain the earnings rather than distributing in term of dividends,for
maximizing the equity shareholder’s wealth.The value of the share is the highest (Rs. 110 ) when D/P
ratio is at its lowest(i.e.,25% )

B Ltd. This company is a ‘’declining firm’’.The rate of return is less than the cost of capital(i.e., r > Ke ).It
will,therefore,be appropriate for this company to distribute the earnings among its shareholders rather
than retaining.The value of share of this company goes on increasing with every increase in the D/P
ratio.

C Ltd. This may be characterized as a ‘’normal firm’’.In case of this compay r = Ke.Hence ,D/P ratio does
not have any impact on the value of the company’s shares.The value of the share continues to be Rs. 80
in all three situations.
Illustration 15.2

The earnings per share of a share of a share of the face value of Rs. 100 of PQR Ltd. Is Rs. 20. It has a rate
of return of 25%.Capitalization rate of its risk class is 12.5%.If Walter’s model is used:

(a) What should be the optimum payout ratio

(b) What should be the market price per share if the payout ratio is zero ?
(c) Suppose, the company has a payout of 25% of EPS, what would be the price per share ?

Solution :

As per Walter’s formula ,the price of the share is

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

(a) If r > Ke, the value of share will increase with every increase in retention.The price of the
share would be the maximum when the firm retains all the earnings.Thus , the optimum
payout ratio is zero for PRQ Ltd.
(b) Calculate of market price when the payout ratio is zero .

P= 0+ (.25/0.125)(20) = Rs. 320

0.125

© Payout of 25% of EPS i.e., 25% of Rs. 20 = Rs. 5 per share :

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

Ke Ke

= 5+(.25/0.125)(20-5) = Rs. 280

0.125

Illustration 15.3
 The earnings per share of ABC Ltd. Is Rs. 10 and rate of capitalization applicable to it is 10%. The
company has before it the options of adopting a pay-out of 20% or 40% or 80%.Using Walter’s
formula,compute the market value of the company’s share if the productivity of retained
earnings is (1) 20% , (2) 10% or (3) 8% .

Solution :

Walter’s Formula :

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

Ke Ke

Dividend payout ratio Dividen per share (Rs)

20% 20% of Rs. 10 = 2
40% 40% of Rs. 10 =4
80% 80% of Rs. 10= 8

Market Price per share if the productivity of Retained Earnings ( r ) is :

(1) At 20% (2) at 10 %

(a) 20% Payout ratio

= Rs. 180
(b) 40% Payout ratio
=Rs. 160

(c ) 80% Payout ratio

=Rs. 120

Illustration 15.4

Determine the market value of equity shares of the company from the following information:

Earnings of the company Rs. 5,00,000

Dividend paid 3,00,000

Number of shares outstanding 1,00,000

Price –earning ratio 8

Rate of return on investment 15%

Are you satisfied with the current dividend policy of the firm ?

If not , what should be the optimal dividend payout ratio ? Use Walter’s Model .

Solution :

Price Earnings Ratio = Market Price

EPS

8 = Market Price

So , Market price = 8* 5 = Rs. 40

EPS = 5,00,000 = Rs. 5

1,00,000

DPS = 3,00,000 = Rs. 3

1,00,000

Dividend payout ratio = DPS * 100 = 3 * 100 = 60 %

EPS 5

Walter’s Model : As the P/E Ratio is given 8 ,and the Ke, is also defined as the reciprocal of P/E
ratio ,therefore, the Ke may be taken as 1/8 =.125.

Since,this is a growth firm having rate of return ( 15%) > cost of capital of 12.5 % therefore, the
company will maximize its market price if it retains 100% of profits. The current market price of
Rs. 40(based on P/E Ratio can be increased by reducing the payout ratio .If the company opts
for 100% retention ( i. e., 0% payout )the market share as per Walter’s formula would be as
follows :
 P = D + ( r / Ke ) ( E – D)

Ke Ke

=0 + (.10 / .8 ) ( 10 – 0 ) = Rs. 156.25

0.8 .08

So, the market price of the share can be increased by following a zero payout.

The P/E ratio at which the dividend policy will have no effect on the value of the firm is such at
which the Ke would be equal to the rate of return,r, of the firm.The Ke would be 10% ( =r ) at the
P / E ratio of 10 . Therefore , at the P/E ratio of 10 ,the dividend policy would have no effect on
the value of the firm.

P = D + (r/Ke ) ( E –D )

Ke Ke

P= 0 + ( .15 / .125 ) ( 5) = Rs. 48

.125 .125

So , the firm can increase the market price of the share up to Rs. 48 by increasing the retention

Ratio to 100 % or in other words , the optimal dividend payout for the firm is 0.

Illustration 15 .5

The earnings per share (EPS ) of a company is Rs. 10. It has an internal rate of return of 15 % and the
capitalization rate of its risk class is 12.5 % . If the Walter’s Model is used –

(1) What should be the optimum payout ratio of the company ?

(2) What would be the price of the share at this payout ?
(3) How shall the price of the share be affected ,If a different payout were employed ?
Solution :

Walter’s Model to determine share value :

Market Price per share = Po = D1 + r/k ( E –D )

Ke Ke

Where, D= dividend per share, E = Earnings per share , r = Return on Investment and Ke=
Capitalization rate.

If r > Ke ,the value of the share will increase as retention increases.The price of the share would be
maximum when the firm retains all the earnings.Thus , the optimum payout ratio is this case is zero
.When the optimum payment is zero,the price of the share is :

P = 0 + (0 .15 / 0.125 ) ( 10 – 0 ) = 12 = Rs. 96

0.125 0.125

If the firm chooses a payout other than zero ,the price of the share will fall. Suppose ,the firm has a
payment of 20%, the price of the share will be :

P = 2 + ( 0.15 / 0.125 ) (10 -2 ) = 11.60 = Rs . 92.80

0.125 0.125

Illustration 15.6

ABC and Co. has been following a dividend policy which can maximize the market value of the firm
as per Walter’s model.Accordingly ,each year ,at dividend time the capital budget is reviewed in
conjunction with the earnings for the periods and alternative investment opportunities for the
shareholders.

In the current year,the firm expects earnings of Rs. 5,00,000.It is estimated that the firm can earn
Rs. 1,00,000 if the profits are retained.The investors have alternative investment opportunities that
will yield them 10% return.The firm has 50,000 shares outstanding .What should be the dividend
payout ratio in order to maximize the wealth of the shareholders ? Also find out the current market
price of the share .
Solution :

The firm is expecting to earn an income of Rs. 1,00,000 on the investment of the profits of current
year, i.e ., Rs. 5,00,000.So,the rate of return, r, is 20% ( i.e., 1,00,000/5,00,000).The opportunity cost
of the shareholders is given at 10%.It means that the rate of return of the firm , r, is more than the
opportunity cost of capital , Ke.

The earnings per share of the firm is Rs. 10 ( i.e., Rs. 5,00,000/50,000).Since , r > Ke ,the optimal D/P
ratio , in order to maximize the wealth of the shareholders,is that the firm need not distribute any
dividend .If no dividend is distributed by the firm ,then , as per Walter’s model , the market price of
the share is :

P = D + ( r/ Ke ) ( E – D)

Ke Ke

= 0 + ( .20 /.10 ) ( 10 – 0 ) = Rs. 200

.10 .10

Illustration 15.7

From the following information supplied to you,ascertain whether the firm is following an optimal
dividend policy as per Walter’s model ?

Total earnings Rs. 2,00,000

Number of equity shares (of Rs. 100 each ) 20,000

Dividend paid 1,50,000

Price / Earnings ratio 12.5

The firm is expected to maintain its rate of return on fresh investment.Also find out what should be
the P/E ratio at which the dividend policy will have no effect on the value of the share ?

Solution :

The EPS of the firm is Rs. 10 (ie., Rs. 2,00,000/20,000).The P/E ratio is given at 12.5 and the cost of
capital Ke, may be taken at the inverse of P/E ratio .Therefore ,Ke is 8 (i.e., 1/12.5).The firm is
 distributing total dividend of Rs.1,50,000 among 20,000 shares,giving a dividend per share of Rs.
7.50.The value of the shares as per Walter’s model may be found as follows :

P= D + ( r/ Ke ) ( E – D)

Ke Ke

= 7.50 + ( .10 /.08 ) ( 10 – 7.5) = Rs. 132. 81

.08 .08

The firm has a dividend payout of 75% ( i.e., Rs. 1,50,000 ) out of total earnings of Rs.
2,00,000.Since,the rate of return of the firm ,r, is 10% and it is more than the Ke , of 8% , therefore ,
by distributing 75% of earnings ,the firm is not following an optimal dividend policy .

In this case, the optimal dividend policy for the firm would be to pay zero dividend and in such a
situation ,the the market price would be

P= D + ( R / Ke ) ( E – D )

Ke Ke

=0 + ( .10 / .8 ) ( 10 -0 ) = Rs . 156.25

.08 .08

So,the market price of the share can be increased by following a zero payout.

The P/E atio at which the dividend policy will have no effect on the value of the firm is such at which
the Ke would be equal to the rate of return , r, of the firm.The Ke would be 10% ( = r) at the P/E ratio
of 10. Therefore,at the P/E ratio of 10,the dividend policy would have no effect on the value of the
firm.

Illustration 15.8)

A company has total investment of Rs.5,00,000 assets and 50,000 outstanding equity shares of Rs.10
each.It earns a rate of 15% on its investments,and has a policy of retaining 50% of the earnings.If the
apprapriate discount rate for the firm is 10%,determine the price of its share using Gordon Model.What
shall happen to the price,if the company has a payout of 80% and 20%?

Solution:

Thae Gordon’ share valuation model is as under:

Po =

Where b= retention ratio = 0.50 or 0.20 or 0.80

K= discount rate=0.10

R=rate of return =0.15

EPS = 0.15 *10=Rs.1.50

At a payment of 505,the price of the share is:

Po = = = Rs. 30.

At a payment of 80%,the price of the share is:

Po =

At a payment of 20%,the price of the share is:

Po=

In the last case,the share price is negative which is unrealistic.

Illustration 15.9)

Assuming that the rate of return expected by investor is 11%;internal rate of return is 12%;and earnings
per share is Rs.15,calculate price per share by Gordon Approach method if dividend payout ratio is 10%
and 30%.

Solution:

MP as per Gordons Approach, Po =

In the given case, =11%

R=12%, EPS=Rs.15

If the dividend payout is 10% then the retention ratio,b is 90%.

Po=

If dividend payout is 30% then the retention ratio b is 70%.

Po =

Illustration 15.10)

RST Ltd. Has a capital of Rs.10,00,000 in equitty shares of Rs.100 each.The shares are currently quoted at
par.The company proposes to declare a dividend of Rs.10 per share at the end of the current financial
year.The capitalization rate for the risk class to which the company belongs is 12%.What will be the
market price of the share at the end of the year,if

(i)A dividend is not declared?

(ii)A dividend is declared?

(iii)Assuming that the company pays the dividend and has net profits of Rs.5,00,000 and makes new
investments of Rs. 10,00,000 during the period,how many new shares must be issued?Use the MM
model.

Solution:

Under MM model,the current market price of equity shares is

Po=

(i)If the dividends is not declared:

100=

100=

P₁=Rs.112

The market price of the equity at the end of the year would be Rs.112.

(ii)If the dividend is declared:

100=

100=

112=10+P₁

P₁=112-10=Rs.102

The market price of the equity share at the end of the year would be Rs.102.

(iii)In case the firm pays dividends of rs. 10 per share out of total profits of Rs.5,00,000 and the plans to
make new investment of Rs.10,00,000 the number of shares to be issued maybe found as follows:

Total earnings Rs.5,00,000

-dividends 1,00,000

Retained earnings 4,00,000

Total funds requires 10,00,000

Fresh funds to be raised 6,00,000

Market price of the share 102

Number of shares to be issued 5,883.35

(Rs.6,00,000/102) Or,the firm should issue 5,883 new shares@Rs102 per share to finance its investment
proposals.

Illustration 15.11)

Textrol Ltd. Has 80,000 shares outstanding.The current market price of these shares is Rs.15 each.The
company expect a net profit of Rs.2,40,000 during the year and it belongs to a risk-class for which the
appropriate capitalization rate has been estimated to be 20%.The company is considering dividend of
Rs.2 per share for the current year.

(a)What will be the price of the share at the end of the year(i)if the dividend is paid and(ii)if the dividend
is not paid?

(b)How many new shares must the company issue if the dividend is paid and the company needs
Rs.5,60,000 for an approved investment expenditure during the year?Use MM model for the calculation.

Solution:As per the MM model,the current market price of the share,Po is:

Po =

So,if the firm pays a dividend of Rs.2,the price at the end of year 1,P₁,is:

15 =

15 =

P₁=Rs.16

If the dividend is not paid,the price would be:

Po =

15 =

P₁=Rs.18

Number of new shares,m,to be issued if the company pays a dividend of Rs.2:

mP₁=I-(E-nD₁)

m*16 = 560000-[240000-(80000*2)]

16m =560000-80000
M = 480000/16 =30000 new shares.

So,the company should issue 30,000 new shares at the rate of Rs.16 per share in order to finance its
investment proposals.

Bestbuy Aotu Ltd.has outstanding 120000 shares selling at Rs.20 per share.The company hopes to make
a net income of Rs.350000 during the year ended 31st march,2011.The company is,considering to pay a
dividend of Rs.2 per share at the end of current year.The capitalization rate for risk class of this company
has been estimated to be 155.Assuming no taxes,answer the questions listed below on the basis of the
Modigliani Miller Dividend Voluation Model:

(i)What will be the price of a share at the end of 31st march,2011,if(a)the dividend id paid;and(b)if the
dividend is not paid?

(ii)How many new shares must the company issue if the dividend is paid and company needs Rs.740000
for an approved investment expenditure during the year?

Solution:

As per the MM model,the price of the share(if the dividend is paid):

Po=

20=

P₁=23-2=Rs.21

As per MM model,the price of the share(if the dividend is not paid):

20 =

P₁=20(1.15)

P₁=Rs.23

The number of new equity shares can be found as follows:

M=[I-(NP-nd₁)]/P₁

==Rs.30,000

Thus,30,000 shares will have to be issued to meet the investment needs of the company.

Illustration 15.13)
Diamond Engineering Company has 10,00,000 equity shares outstanding at the start of the accounting
year1997.The ruling market price per share is Rs.150.The board of directors of the company
contemplates declaring Rs.8 share as dividend at the end of the current year.The rate of capitalization
appropriate to the risk-class to which the company belongs is 12%.

(a)Based on MM model approach,calculate the market price per share of the company when the
contemplated dividend is(i)declared(ii)not declared.

(b)How many new shares are to be issued by the company at the end the accounting year on the
assumption that the net income for the year is Rs.2?Investment budget is Rs.4 crores and(i)the above
dividends are distributed and(ii)they are not distributed.

(c)Show that the total market value of the shares at the end of the accounting year will remain the same
whether dividends are either distributed or not distributed.Also find out the current market value of the
firm under both situations.

Solution:

(a)Existing market price share,Po = Rs.150

Contemplated DPS D₁, = Rs.8

Rate of capitalization, =0.12

Market price as per MM approach is Po=

(i)If contemplated dividends are declared,then

Rs.150 =

Or, P₁ =Rs.160

(ii)If the devidends are not declared,then

Rs.150 =

Or,P₁=Rs.168.

(b)Calculation of number of shares to be issued:

Dividends distributed Dividends not distributed

Net Income 200 200
Total dividend 80 -
Retained earnings 120 200
Investment budget 400 400
Amount to be raised by new issues 280 200
Relevant market price(Rs.per share) 160 168
No.of new shares to be issued 1,75,000 1,19,050
(c)Total number of shares at the end of the year

Existing shares 10,00,000 10,00,000

+new shares issued 1,75,000 1,19,048

11,75,000 11,19,000

Market price per share(Rs.) 160 168

Market value of share 11,75,000*160 11,19,048*16

=18,80,00,000 =18,80,00,064

Thus,the total market value of shares remains almost unaltered whether dividends are distributed or
not distributed at all.

The current market value of the firm.nPo,under both the conditions of dividend maybe found with the
help of equation17.5 as follows:

(a) nPo =

=Rs.15,00,00,000

(b)If dividend of Rs.8 is not paid:

nPo=

=Rs.15,00,00,057

So the current market value of the firm is also almost same whether the dividend of Rs.8 is paid or
not at the end of current year.

Illustration 15.14)

A company belongs to a risk-class for which the appropriate capitalization rate is 10%.It currently
has outstanding 25,000 shares selling at Rs.100 each.The firm is contemplating the declaration of
dividend of Rs.5 per share st the end of the current fiscal year.The company expects to have a net
income of Rs.2.5 lacs and a proposal for making new investments of Rs.5 lacs.Shaow that under the
MM assumptions,the payment of dividend does not affect the value of the firm.

Solution:

Existing market price share,Po = Rs.100

Contemplated DPS,D₁ = Rs.5

Rate of capitalization, = 0.10

Market price as per MM approach is Po=

(i)If contemplated dividends are declared,then

Rs. 100 =

Or, P₁ =Rs.105

(ii) If dividends are not declared,then

Rs.100 =

P₁ =Rs.110

(b) Calculation of number of shares to be issued:

Dividends distributed Dividends not distributed

Net Income Rs.250000 Rs.2,50,000
Total Dividends 125000 -
Retained Earnings 125000 250000
Investment Budget 500000 500000
Amount to be raised by new issues 375000 250000
Relevant market price(Rs.per share) 105 110
No.of new shares to be issued 3571.4 2272.7
(c) Total number of shares at the end of the year:
Existing shares 25000.00 25000
+New shares issued 3571.4 2272.7
28,571.4 27,272.7
Market price per share(Rs.) 105 110
Market value of share 28,571.4*105 27,272.7*110
=30,00,000 =30,00,000
Thus,the total market value of shares remains unaffected whether dividends are distributed at
all.It may be noted that the number of the new shares to be issued have been taken exact at
3571.4 and 2272.4.But the shares cannot be issued in fractions.If the number of new shares to
be issued is taken at integer values of 3572 and 2273 respectively,then the total market value of
the firm would be Rs.30,00,000(i.e 28.572*105)and Rs.30,00,000(i.e27,273*110)which are
almost same.
Illustration 15.15)
The capital structure of ABC Ltd. Consists of 50,000 equity shares of Rs. 10 each.It does not have
any preference shares or debentures.It has just paid a dividend of Rs.1.20 per share.The firm has
a policy of maintaining 1005 dividend payout ratio and does not expect any growth in its
earnings.It has before it an investment proposal costing rs.5,00,000 per annum.The cost of
capital for the firm is 8%.
Calculate the current market price of the share.Using the present value of dividend
concept,calculate the share price if the proposal investmentis undertaken without resorting to
any external finance.Also show how an investor can increase his cash inflow next year and
maintaining constant income thereafter:
Solution:
The firm has just paid a dividend of Rs.1.20 and does not expect any growth in
earnings,therefore,on the basis of 100% D/P ratio,the dividend at the end of the current year,D₁
would also be Rs.1.20.The current market price of the share,given the at 18% may be found as
follows:
Po =
If the investment proposal is to be financed without any external financing,it means that the
new project will be financed by retained earnings only.Any profit remaining after the
investments financing will be available for dividend distribution.So,

For Year 1: Rs.

Total profits(5,00,000*Rs.1.20) 6,00,000
Retained earnings required for investment 5,00,000
Profit available for distribution 1,00,000
No. of shares 5,00,000
Dividend per share(year 1) Rs.0.20

For Year 2:
Increase in profits as aresult of investment Rs.1,00,000
Regular profit 6,00,000
Total profit 7,00,000
No. of shares 5,00,000
Dividend per share for year2 and thereafter Rs.1.40
The new current share price may now be found by taking the present value of dividend of
Re.0.20 for year1 plus the present value of the perpetuity of dividend of Rs.1.40 as follows:
Po =
Now,assume that an investor has 50,000 shares of this company.His current income in the form
of dividends from the company would be Rs.60,000(i.eRs.60,000*rs.1.20).
The number of share needed to maintain his income at Rs.60,000 is Rs.42,857
only(i.eRs.60,000/1.40).Therefore,this investor can sell 7,143 shares(i.e50,000-42,857).
 The share price at the end of year 1 ia as follows:
P₁=
So,the investor would sell 7143 shares at a price of Rs.7.77 per share to give him a total proceed
of rs.55,501 at the end of the year 1.At the same time he will also be receiving Rs.10,000 as
dividend for current year(i.e50,000*Re.0.20)So,his total income/proceedsat the end of year
1would be Rs.65,501(i.e10,000+55,501)resulting in increase of Rs.5501(i.e65,501-
Rs.60,000)Therefore the investor would be able to increase his cash inflow by Rs.5501 next year
an dto maintain his dividend income of Rs.60,000 thereafter by selling 7,143 shares at the
market price of Rs.7.77 per share at the end of year 1.

PROBLEMS

P 15.1 The earning per share of a company are Rs. 10.It has rate of return of 15% and the capitalization
rate of risk class is 12.5%.If Walter’s model is used : (1) What should be the optimum payout ratio of the
firm? (2) What would be the price of the share at this payout? (3)How shall the price of the share be
affected if a different payout was employed?

[Answer :As r>ke , the optimal payout ratio is zero.The price of the share would be Rs. 96]

P 15.2 The earnings per share of a Company are Rs. 8 and the rate of capitalization applicable to the
company is 10%.The company has before it an option of adopting a payout ratio of 25% or 50% or
75%.Using Walter’s formula of dividend payout compute the market value of the company’s share if the
productivity of retained earnings is (1) 15% , (2) 10% and (3) 5%.

P 15.3 A company has a total investment of Rs. 5,00,000 in assests and 50,000 outstanding common
shares at Rs. 10 per shares(par value).It earns a rate of 15% on its earnings.If the appropriate discount
rate of the firm is 10 per cent,determine the price of its share using Gordon’s model.What shall happen
to the price of the share if the company has payout of 80 per cent or 20 per cent ?

[Answer:Price as per Gordon’s model , at 50% payout is Rs. 30;at 80% payout is Rs. 17;and at 20%
payout is Rs. -15(which is absurdity).]

P 15.4 The earnings per share of a company ae Rs.16.The market rate of discount applicable to the
company is 12.5%.Retained earnings can be employed to a yield a return of 10%.The company is
considering a pay-out of 25%,50% and 75%.Which of these would maximize the wealth of shareholders.

[Answer:75% payout.]

P 15.5 Calculate the market price of a share of ABC Ltd. Under (1)Walter’s formula;and

(2)dividend growth model from the following data:

Earnings per share Rs. 5

Dividend per share Rs. 3

Cost of capital 16%

Internal rate of return on investment 20%

Retention ratio 40%

[Answer: (1) Rs. 34.38; (2) Rs. 37.50]

15.6)The Agro chemicals company belongs to a risk class for which the appropriate capitalization
rate is 10%.It currently has 1,00,000 shares selling at Rs.100 each.The firm is contemplating the
declaration of rs.5 as dividend at the end of current financial year,which has just begun.What
will be the price of the share at the end of the year,if a dividend is not declared?What will it be if
it is?Answer these on the basis of Modigliani and Miller model and assume no
taxex.[Answer:Rs.110 and Rs.105]

15.7)XYZ Ltd.had 50,000 equity shares of Rs10 each outstanding on january 1.The shares are
currently being qouted at par in the market.The company nowintends to pay a dividend of rs.2
per share for the current calender year.It belongs to a risk class whose appropriate capitalization
rate is 15%.Using MM approach and assuming no taxes,ascertain the price of the company’s
share as it is likely to prevail at the endof the year(i)when dividend is declared(ii)when no
dividend is declared.Also find out the number of new equity shares that the company must issue
 to meet the investment needs of Rs.21lacs,assuming a net income of Rs.1.1lacs and also
assuming that the dividend is paid.[Answer:Price at the end of the current year would be Rs.9.50
and Rs.11.50 respectively.New shares to be issued are 20,000]

15.8)The ABC Ltd.currently has outstanding 1,00,000 shares selling at Rs.100 each.The firm is
considering to declare a dividend of Rs.5 per share at the end of the current fiscal year.The
firm’s opportunity cost of capital is 10%.What will be the price of the share at the end of the
year if(i)a dividend is not declared,(ii)a dividend is declared?
Assuming that the firm pays the dividend, has net profits of Rs.10,00,000 and makes new
investments of rs.20,00,000 during the period,how many new shares must be issued?Use MM
model.[Answer:price at the end of the current year would be Rs.110 and Rs.105
respectively.New shares to be issued by the company are 14,285]

15.9)the present share capital of A Ltd.consist of 1,000 shares selling at Rs.100 each.The
company is contemplating a dividend of Rs.10 per share at the end of the current fiscal year.The
company belongs to a risk class for which appropriate capitalization rate is 20%.The company
expects to have a net income of rs.25,000.What will be the price of the share at the end of the
year if(i)dividend is not declared,and(ii)a dividend is declared.Presuming that the company pays
the dividend and has to make new investment of Rs.48,000 in the coming period,how new
shares be issued to finance the investment program?You are required to use the MM model for
this purpose.[Answer:The price of the share would be Rs.120 and Rs110 respectively and the
company is required to issue 300 new shares if dividend is paid.]

15.10)A textile company belongs to a risk class for which the appropriate PE ratio is 10.It
currently has 50,000 outstanding shares selling at Rs.100each.The firm is contemplating the
declaration of Rs.8 dividend at the end of the fiscal year which has just started.Given the
assumption of MM,answer the following questions.
(i)What will be the price of the share at the end of the year if : (a)dividend is not declared
(b)dividend is declared.
(ii)Assuming that the firm pays the dividend and has a net income of Rs.5,00,000 and makes new
investments of Rs.10,00,000 during the period,how many new shares must be issued?

(iii)What would be the current value of the firm: (a)if dividend is declared,(b)if dividend is not
declared?[Answer: The price of the share would be Rs.110 and Rs.102 respectively.The company would
be required to issue 9,00,000/102 new shares.The current market value of the firm would be
Rs.50,00,000 and the expected market value of the firm at the end of current year would be
Rs.60,00,000.]

MULTIPLE CHOICE QUESTION

True and False:

(i)Dividend is a part of retained earnings.

(ii)Dividend is compulsorily payable to preference shareholders.

(iii)Effective dividend policy is an important toolto achieve the goal of wealth maximization.

(iv)Retained earnings is an easily available source of funds at no explicit cost.

(v)Dividend payout ratio refers to that portion of the total earnings which is distributed among
shareholders.

(vi)% rate of dividend is also known as dividend payout ratio.

(vii)There is a difference of opinion on relationship between dividend payment and value of the firm.

(viii)Walters model supports the view that dividend is relevant for value of the firm.

(ix)Gordons model suggest that dividend payment does not affect the market price of the share.

(x)In the walters model,the DP ratio should depend upon the relationship between r and Ke.

(xi)Residual theory says that dividend decision is no decision.

(xii)Mmmodel deals with irrelevance of dividend decision.

(xiii) MM Model is a fool proof model of dividend irrelevance.

(xiv) In teh arbitrage process of MM Model ,teh dividends paid by a company are repalced by fresh
investment.

(xv) MM Model asserts that value of the firm is not affected whether the firm pays dividend or not.

[ Answer: (i) F , (ii) F , (iii) T , (iv) T , (v) T , (vi) F , (vii) T , (viii) T , (ix) F , (x) T , (xi) T , (xii) T , (xiii) F , (xiv) T ,
(xv) T .]

1.Walters model suggest for 100% DP ratio when:

(a)Ke=r

(b)Ke<r

(c)Ke>r

(d)Ke=0
2.If afirm has Ke<r,the walter’s model suggest for:

(a)0%payout

(b)100% payout

(c) 50% payout

(d) 25% payout

3. Walter’s model suggests that a firm can always increase the value of th e share by:

(a)Increasing Dividend

(b)Decreasing Dividend

(c)Constant Dividend

(d)None of the above

4.’Bird inhand’argument is given by:

(a)Walter’s model

(b)Gordon’s model

(c)MM model

(d)Residual Theory

5.Residuals theory argues that dividend is a:

(a)Relevant Decision

(b)Active Decision

(c)Passive Decision

(d)Irrelevant Decision

6.Dividend irrelevance agrument of Mmmodel is based on:

(a)Issue of debentures

(b)Issue of bonus shares

(c)Arbitrage

(d)Hedging
Which of the following is not true for MM Model ?

(a) Share price goes up if dividend is not paid

(b) Share price goes down if dividend is not paid
(c) Market value is unaffected by Dividend policy
(d) All of the above.

8.Which of the following stresses on investor’s preference for current dividend than higher future
capital gains?

(a) Walter’s Model

(b) Residuals Theory

© Gordon’s Model

(d)MM Model.

9. MM Model of Dividend irrelances uses arbitrage between :

(a) Dividend and Bonus

(b) Dividend and Capital Issue

© Profit and Investment

(e)None of the above

10. If Ke = r ,then under Walter’s Model.which of the following lowing is irrelevant ?

(a) Earnings per share

(b) Dividend per share

© DO Ratio

(d)None of the above.

11. MM Model argues that dividend is irrelevant as

(a) the value of the firm depends upon earning power

(b) the investors buy shares for capital gain

( c ) dividend is payable after deciding the retained earnings.

(d)dividend is a small amount.

12. Which of the following represents passive dividend policy ?

(a) that dividend is paid as a % of EPS

(b) that dividend is paid as a constant amount

© that dividend is paid after retaining profits for reinvestment

(d)all of the above

13. In case of Gordon’s Model ,the MP for zero payout is zero.It means that :

(a) Shares are not traded.

(b) Shares available free of cost

© Investors are not raedy to offer any price

(d)None of the above

14. Gordon’s Model of dividend relevance is same as :

(a) No-growth Model of equity valuation

(b) constant growth Model of equity valuation

© Price-earning ratio

(d)Inverse of Price Earning Ratio

15. If ‘r’ = ‘Ke’ , than MP by Walter’s Model and Gordon’s Model for different payout ratios would be:

(a) Unequal

(b) Zero

© Equal

(d)Negative.

[Answers : 1(c ), 2 (A), 3(d) , 4(B) , 5(c) , 6(c) , 7(c) , 8(c), 9(b), 10(c) , 11(a) , 12(c) , 13(c) , 14(b) , 15(c) ].