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Dividend Policy

1) The Cost of capital and the rate of return on investment of WM


Ltd. is 10% and 15% respectively. The company has one million
equity shares of Rs. 10 each outstanding and its earnings per share
is Rs. 5. Calculate the value of the firm in the following
situations using Walters Model:
(i)
100% retention
(ii) 50% retention and
(iii) No retention
Comment on your result.
2) The earnings per share of a company is Rs.16. The market
capitalization rate is applicable to the company is 12.5%. Retained
Earnings can be employed to 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 as per Walters Model?
3) Following are the details regarding three companies A Ltd, B
Ltd, C Ltd. :
Details
A Ltd
B Ltd
C Ltd
Internal
rate
of
15%
5%
10%
return
Cost of equity
10%
10%
10%
Earnings per share
Rs.8
Rs.8
Rs.8
Calculate the value of equity share of each of these companies
applying Walters formulae when dividend pay out ratio (D/P Ratio) is
(i) 50% (ii) 75% and (iii) 25%.
What conclusion do you draw?
4) Details regarding three companies are given below:
A Ltd
r = 15%
Ke = 10%
E = Rs.10

B Ltd
r = 10%
Ke = 10%
E = Rs.10

C
r
Ke
E =

Ltd
= 8%
= 10%
Rs.10

By using Walters Model, you are required to(i) Calculate the value of an equity share of each of these
companies when dividend pay out ratio is (a) 20% (b) 50% (c) 0% and
(d) 100%
(ii) Comment on the result drawn.
5) ABC Ltd. was started a year back with a paid up capital of Rs.
40,00,000.The other details are as under:
Earnings of the company
Rs. 4,00,000
Dividend Paid
Rs. 3,20,000
Price earnings ratio
12.5
Number of Shares
40,000
You are required to find out whether the companys dividend pay out
ratio is optimal using Walters Model formula.
6) Calculate the market price of a share of ABC Ltd. under
(i)Walters Formula; and (ii) Dividend growth model from the
following data:

Earnings per share


Dividend per share
Cost of Capital
Internal rate of return on investment
Retention Ratio

Rs. 5
Rs. 3
16%
20%
50%

7) The Beta co-efficient of Target Ltd. is 1.4.The company has been


maintaining 8% rate of growth in dividends and earnings. The last
dividend paid was Rs.4 per share. Return on Government Securities
is 10%. Return on market portfolio is 15%. The current market
price of one share of Target Ltd. is Rs.36.
(i) What will be the equilibrium price per share of Target
Limited?
(ii) Would you advise purchasing the share?
(8) A company has belongs to 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 at the end of the
current financial year. The company expects to have a net income
of Rs 2.5 lakhs and has a proposal for making new investments of
Rs 5 lakhs.
Show that under the M M Assumptions the payment of dividend does
not effect the value of the firm.
9) D Ltd. has 10 lakhs equity shares outstanding at the beginning of
the account year 2002.The current market price of the shares is Rs
150 each. The Board of directors of the company has recommended Rs
8 per share as dividend. The rate of capitalization, appropriate
to the risk- class to which the company belongs, is 12%.
(i) Based on M-M approach, calculate the market price of the share
of the company when the recommended dividend is (a) declared and
(b) not declared.
(ii) How many new shares are to be issued by the company at the
end of the accounting on the assumption that the net income for
the year is Rs 2 crore and the investment budget is Rs 4 crores
when (a) the above dividends are distributed and (b) dividends are
not declared?
(iii) Show that the market value of the shares at the end of the
accounting year will remain the same whether dividends are
distributed or not declared.
10) RST Limited has a capital of Rs 10,00,000 in equity shares of Rs
100 each. The shares are currently quoted at par. The company
proposes declaration of a dividend of Rs 10 per share. 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 years, if (i) no dividend is declared; and (ii) 10%
dividend id declared?
Assuming that the company pays the dividend and has net profits of
Rs 5,00,000 and makes a new investments of Rs 10,00,000 during the
period, how many new shares must be issued? Use the M.M. Model.
11) Exponent Limited had 50,000 equity shares of Rs 10 each
outstanding on 1st April. The company intends to pay a dividend of

Rs 2 per share for current financial year. It belongs to a risk


class whose appropriate capitalization rate is 15%
Using Modigliani Miller model and assuming no taxes, ascertain
in price of companys share as it is likely to prevail at the end
of the year when (i) dividend is declared; and (ii) no dividend is
declared.
Also find out number of new equity shares that the company must
issue to meet its investment needs of Rs 2,00,000 assuming net
income of Rs. 1,10,000 and assuming that the dividend is paid.
12.

The following data is available for Newton Limited:


Earnings per share
= Rs.6.00
Rate of return
= 18 percent
Cost of capital
= 15 percent
(a) If Walters valuation formula holds, what will be the price
per share when the dividend payout ratio is 30 percent? 40
percent?
(b) If Gordon's basic valuation formula holds, what will be the
price per share when the dividend payout is 30 percent, 40
percent?

13.

Handsome Apparels expects that its net income and capital


expenditures over the next four years will be as follows:
Year
1
2
3
4

Net Income (Rs.)


40,000
60,000
25,000
34,000

Capital Expenditures (Rs.)


12,000
10,000
6,000
7,000

The company has 10,000 outstanding shares currently on which it


pays a dividend of two rupees per share. The debt- equity target
of the firm is 1:1
Required:
(a) What will be the dividend per share if the company follows a
pure residual policy?
(b) What external financing is required if the company plans to
raise dividends by 15 percent every 2 years?
(c)
What will be the dividend per share and external financing
requirement if the company follows a policy of a constant 50
percent payout ratio?
14.

Young Turk Associates expects that its net income and capital
expenditures over the next five years will be as follows:
Year
1
2
3
4
5

Net Income (Rs.)


70,000
40,000
85,000
38,000
105,000

Capital Expenditures (Rs.)


25,000
50,000
4,000
57,000
14,000

The company has 20,000 outstanding shares currently on which it


pays a dividend of two rupees per share. The debt- equity target
of the firm is 3:2

Required:
a. What will be the dividend per share if the company follows a
pure residual policy?
b.
What external financing is required if the company plans to
raise dividends by 20 percent every 3 years?
c. What will be the dividend per share and external financing
requirement if the company follows a policy of a constant 60
percent payout ratio?