~ I

idend Policy And Decisions

17.3

The MM hypothesis can be explained in another form also pre5U1D -"lha investment required by the firm on account of payment of dividends is financed out of the new issue c; e equatio n:
In such a case, the number of shares to be issued can be computed
VI"tb . ~

r~z ~ollowi.ng

I (E-nDj)

Pj

Further, the value of the firm can be ascertained with the help of the following formula: nPo = (n+m)Pj-(I-E) l+ke

number of shares to be issued. Investment reqiiired. E Total earnings of the firm during the period. PI Market price per share at the end oTthe period. Ke = Cost of equity capital. n number of shares outstanding at the beginning of the period. DI = . DiViOe!id to be paid at the end of the period. nP = varue0f the firm o Let us take the following illustration to illustrate MM hypothesis of irrelevance of dividend to the -aluation of firm. . lIIustration~ Ltd. belongs to a risk class for which the appropriate capitalisation .rate is 10%. :- currently has outstanding 5,000 shares selling at ~100 each. The firm is contemplating the declaration of ~ ridend of ~6 per share at the end of the current financial year. The company expects to have a net income ":: ~50,000 and has a proposal for making new investments of ~l ,00,000. Show that under the MM hypothesis, e payment of dividend does not effect the value of the firm. Solution: A) Value of the firm when dividends are paid: (I) Price of the share at the end of the current financial year PI = Po (l+ke) - D, = 100 (1+.I0}-6 = 100 x 1.10-6 =II0--6=~104
(ii)

Where,

m -I

Number of shares to be issued

m

I-(E- nDJ)

1,OO,()()O- (50,000 - 5, oon x6) 104

fri) Value of the firm

nP
o

80,000 104
_ (n+m)P1-(1-

I+kc

E)

5 ,000 - 80,O()0 x l 04 - (1 ,00,000 - 50,0(0) 104

1+. 10 5,20,000+80,000 x ] 04 -(50000) ]04 l' 1.1 ()