Dividend

Irrelevant
Traditional Approach
M-M Approach
Relevant
Walter’s Approach
Gordon’s Approach

Traditional Approach or Residual Approach

The Company does not have any dividend policy.
Payment of dividend is a residual decision.
RoI > K, Retain
Otherwise i.e. RoI < K then pay dividend

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Modigliani-Miller Approach
Arbitrage:
Buy where the prices are low and sell where the prices are high.
RST Ltd. 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 to declare a dividend of Rs. 10 per share at the end of
the current financial year. The capitalization rate for the risk class
of 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.
FV = 100, MP (P0) = 100, V0= 10,00,000, N = 10,000 D1 =10,
K=12%, E=5,00,000, I=10,00,000
V0 = 10,00,000 (N X P0 - 10,000 X 100)
If the Company does not pay dividend:
P1 + D1
Po = , P1 = Po (1 + K e ) − D1
(1 + K e )

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P1 = Po (1 + K e ) − D1 = 100(1 + 0.12) −0 = 112
I − {E − (N × D1 )}
m=
P1

10,00,000 − {5,00,000 − (10,000 × 0)}

= = 4464.29
112
(N + m)P1 − I + E
Vo = NPo =
(1 + K e )
(10,000 + 4,464.29)112 − 10,00,000 + 5,00,000
Vo =
(1 + 0.12)
= 10,00,000.428 = 10,00,000
If the Company pays dividend:
P1 = Po (1 + K e ) − D1 = 100(1 + 0.12) − 10 = 102
I−{E−(N×D1 )}
m= =
P1
10,00,000−{5,00,000−(10,000×10)}
=5882.3529
102
(N + m)P1 − I + E
Vo = NPo =
(1 + K e )

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Vo
(10,000 + 5882.3529)102 − 10,00,000 + 5,00,000
=
(1 + 0.12)
= 9,99,999.99 = 10,00,000

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Walter’s Approach:

Relationship Category Optimum Impact on MP

Pay-out
Ratio
MP decreases
RoI>K Growth 0% as pay-out
increases
MP increases
RoI<K Declining 100% as pay-out
increases
RoI=K Normal No No impact

Walter's Model
200

180

160

140
Market Price (Rs)

120

100

80

60

40

20

0
0 25 50 75 100
Dividend Payout Ratio

Growth Firm Normal Firm Declining Firm

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Po = PV of Dividends + PV of benefits on Retained Earnings
[𝐄−𝐃]𝐫
𝐃 𝐊𝐞
= +
𝐊𝐞 𝐊𝐞

r
D + (E − D)
Ke
Po =
Ke

Using the Walter’s Model show the effect of the dividend policy on the
market price per share of Umber Private Limited. Let the payout ratio be
0%, 25%, 50%, 75% and 100%.

Following information has been given on Umber Pvt. Ltd.

EPS = Rs. 8, Cost of Capital (K) = 12%, Assumed rate of return:

a) 15%,
b) 10%
c) 12%

RoI = 15%, RoI = 10%, RoI = 12%,

Growth Declining Normal
Dividend Pay-out= 0%, E = 8, D=0
Po = 0.10 0.12
0 + (8 − 0) 0 + (8 − 0)
0.15
0+(8−0)0.12 Po = 0.12 Po = 0.12
0.12 0.12 0.12
= 83.33 = 55.55 = 66.66

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 Dividend Pay-out= 25%, E = 8, D=2
Po = 0.10 0.12
2 + (8 − 2) 2 + (8 − 2)
2+(8−2)
0.15
Po = 0.12 Po = 0.12
0.12
0.12 0.12 0.12
= 79.17 = 58.33 = 66.66
Dividend Pay-out= 50%, E = 8, D=4
Po = 0.10 0.12
4 + (8 − 4) 4 + (8 − 4)
4+(8−4)0.12
0.15
Po = 0.12 Po = 0.12
0.12 0.12 0.12
= 75.00 = 61.11 = 66.66
Dividend Pay-out= 75%, E = 8, D=6
Po = 0.10 0.12
6 + (8 − 6) 6 + (8 − 6)
6+(8−6)
0.15
Po = 0.12 Po = 0.12
0.12
0.12 0.12 0.12
= 70.83 = 63.88 = 66.66
Dividend Pay-out= 100%, E = 8, D=8
Po = 0.10 0.12
8 + (8 − 8) 8 + (8 − 8)
8+(8−8)
0.15
Po = 0.12 Po = 0.12
0.12
0.12 0.12 0.12
= 66.66 = 66.66 = 66.66

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 P1 +D1
Po = , P1 = Po (1 + K e ) − D1
(1+Ke )
P1 + D1
Po = ,
(1 + K e )
P1 = Po (1 + K e ) − D1
I − {E − (N × D1 )}
m=
P1
(N + m)P1 − I + E
Vo = NPo =
(1 + K e )
r
D + (E − D)
Ke
Po =
Ke
E (1 − b)
Po =
K e − (RoI × b)

Gordon’s Approach
Gordon's Model
40
35
30
Discount Rate (%)

25
20
15
10
5
0
0 5 10 15 20 25 30 35 40
Time Period (Years)

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 D1
Ke = +g
P0
D1
P0 =
Ke − g

E (1 − b)
Po =
K e − (RoI × b)
The following information is collected from the annual reports
of J Ltd.:
Profit before tax Rs. 2.50 Crore
Tax rate 40 percent
Retention ratio 40 percent
Number of outstanding shares 50,00,000
Equity capitalization rate 12 percent
Rate of return on investment 15 percent
What should be the market price per share according to
Gordon’s model of dividend policy?
PBT – 250 Lakhs
(-) Tax @ 40% - 100 Lakhs
PAT – 150 Lakhs (EE)
EPS = EE/N = 150 Lakhs/ 50 Lakhs = Rs. 3
E (1 − b) 3 (1 − 0.4) 1.8
Po = = =
K e − (RoI × b) 0.12 − (0.15 × 0.4) 0.06
= Rs. 30
(RoI × b) = g

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