ustration 11.

1 CALCULATION OF DIVIDEND PER SHARE AT 50% PAYOUT

nZ company expects with some degree of certainty to Year Proflit Dividends DPS Investment Ext. Fnancing
senerate the following profits and to have the following ? 50,00,000 25,00,000 72.50 ? 20,00,000
canital investment during the next five years. 2 40,00,000 20,00,000 2.00 25,00,000 5,00,000
12,50,000 1.25 32,00,000 19,50,000
3 25,00,000
(Figures in '000) 4 20,00,000 10,00,000 1.00 40,00,000 30,00,000
1 2 7,50,000 0.75 50,00,000 42,50,000
lear 3 4 5 5 15,00,000|
Net Income 5,000 4,000 2,500 2,000 1,500
Investment 2,000 2,500 3,200 4,000 5,000 Mustration 11.2
The company currently has 10,00,000 shares of equity and Two companies - A Ltd. and B Ltd. are in the same industry
pavs dividends of 5 per share. with identical earnings per share for the last five years. ALtd.
(9) Determine dividends per share if dividend policy is treated has a policy of paying 40% of earnings as dividends, while the
as a residual decision. BLtd. pays a constant amount of dividend per share. There is
disparity between the market prices of the shares of the two
() Determine dividends per share and the amounts of the companies. The price of the A's share is generally lower than
external financing that will be necessary if a dividend that of the B, even through in some years ALtd. paid more
payout ratio of 50% is maintained. dividends than B. The data on earnings, dividends and market
Solution : price for the two companies are as under :
CALCULATION OF DIVIDEND PER SHARE A LTD.
Year EPS DPS Market price
Year Profit Investment Balance DPS Ext. Financing
30,00,000 73.00 2012 4.00 1.60 ? 12.00
50,00,000 20,00,000
2 40,00,000 25,00,000 15,00,000 1.50 0 2013 1.50 0.60 8.50
3 25,00,000 32,00,000 7,00,000 2014 5.00 2.00 13.50
4 20,00,000 40,00,000 20,00,000 2015 4.00 1.60 11.50
5 15,00,000 50,00,000 0 35,00,000 2016 8.00 3.20 14.50
 230 PART IV DIVIDEND DECISION
is
The Profit after ax for the year 2016 6,00,000.
BLTD. dividendcn t. Thene
(ompany is contemplating the payment of
Year Ers DPs Market prlce Share for the year 2016. You are required to find ut
(a) EPS and maximum DPSif 10% of the current year profits
2012 t400 tI80 IR50
12.50
2013 L50
$00
180
1.80 1250 are required to be retained.
2014
2015 4.00 180 12.50 (b) Residual DPS if 10% of current year profits to be retaix- .
and fresh investment proposals hefore the
2016 8.00 L80 15.00
requires 2,50,000 for which no horrowing is Company
() Calulate (a) pavout ratio, (b) dividend vield, and
proprsed
Solutlon:
() earning vield for both the companies.
() What are the reasons for the differences in the market EPS of the company :
prices of the two companies share?
Profit After Tax
Less Preference Share Dividend
6,00,000
(in What can be done by the A Ltd. to increase the market 1,30,000
Profit for Equity Shareholders
price of its shares ?
EPS (4,50,000 2,20,000)
450,000
Solution: 2.045
Maximum DPS:
The Payout ratio is DPS ÷ EPS
The Dividend yield is DPS MP
Profit After Tax 6,00,000
The Earnings yield is EPS MP
Less Retained earnings 60,000
Profit available for distribution
The following table shows payout, dividend yield and earn Pref. Share dividend
5,40,000
ings yield for ALtd. and B Ltd. 1,50,000
Profit for Equity shareholders 3,90,000
Year Payout Dividend yield Earnings yield
Cash and Bank balance 3,50,000
A Ltd. B. Ltd. ALtd. B. Ltd. ALtd. B. Ltd.
The company can distribute dividends of ? 3,90,000 but the
2012 40 45 .13 .13 33 3
2013 40 1.20 .07 .14 .18 .12 cash available is only 3,50,000. So, maximum DPS is
2014 40 36 .15 .14 37 40 1.59 (ie, 3,50,000 -+ 2,20,000).
2015 40 45 14 .44 35 32 If the company has investment plans of 2,50,000, then the
2016 40 23 .22 .12 55 53 cash available isonly 1,00,000 and the maximum DPS would
It seems that investors evaluate the shares of these two be0.45 (ie, 100,000-+ 2,20,000).
companies in terms of dividend payments. The average divi llustration 11.4
dend per share overa period of five years for both the firms
is 1.80. But the average market price for the B Ltd. Import Replacement Ltd. specialises in producing goods to
R13.20) has been 10% higher than the average market price substitute imports from the USA. The managing director of
for the ALtd. (R 12). The market has used ahigher capitaliza the company, Ajay, is seriously concerned about the dividend
tion rate to discount the fluctuating dividend per share of the payout policy of the company. He has asked you as acompany
ALtd., thus valuing the shares of the ALtd. at a lower price secretary-cum-finance director to suggest dividend payout
than that of the B Ltd. under each of the following alternative policies :
It is obvious that the market evaluates these firms in terms of Policy I:Adividend payout of ? 2.00 per share, increasing by
dividends. Ahigher market price might be obtained for the <0.20per share over the previous year whenever the dividend
shares of the ALtd., if it increases its dividend payout ratio. payout falls below 50% for the two consecutive years.
The company should evaluate this option in light of funds Policy II:A dividend payout of? 1.00per share for each period
requirements.
except when earnings per share exceed ? 6.00when an extra
dividend equal to 80% of earnings beyond 6.00 would be
llustration 11.3 paid.
Following information is available in respect of Eriksson Ltd.
as on Dec. 31, 2016: The earnings per share of the company over the last 10 years
is shown in the following table:
15% Pref. Share Capital ? 10,00,000
Year Earnings per Share
Equity Share Capital (FV? 10) 22,00,000
Securities Premium A/c 2016 78.00
8,00,000 2015 7.60
Reserves 7,00,000
Cash and Bank Balance (after paymernt of 2014 6.40
2013
Preference Dividend) 3,50,000 2012
5.60
6.40
2011 4.80
 CH. 11:DIVIDEND POLICY:DETERMINANTS AND CONSTRAINTS 231
Year
Earnings per Share Year
Earning per share Polley I Polley I
2010 2.40
2000 2008 L.00 200 100
3.60
2007 0.50 2.00
2008 1.00
2007 0.50 The above calculations are based on the assurnptionthat the
ouarealso requiredto discuss the pros and cons of each of company has adequate reserves to pay dividends when prof-
its are low. Under Policy I, the cornpany pays a constant
dhidendIpolicies mentioned above. amount of dividend of ? 2per share and enhanced armount of
dividend of ? 0.20 per share over the previous years when
CALCULATION OF DIVIDEND PAYOUT UNDER dividend-payout ratio falls below 50% for two consecutive
ALTERNATIVE POLICIES years. This policy provides the owners with information
Earning per share
indicating that the firm is okay. Under this Policy, the firm
Policy I Policy II
Year pays dividend even when earning is inadequate and thus
7 8.00 73.00 1.00 + (2 X0.80) = 2.60
2016 provide stability in the dividend payment.
7.60 2.80 1.00 × (1.60 X 0.80) = 2.28 Under Policy II, the company pays dividend at ?lper share
and extra dividend when earning exceeds 6. This policy is in
6.40 2.60 1.32
2014
2013
5.60 2.40 1.00
nature of low regular plus extra dividend policy. By establish
2012 6.40 2.20 1.00 + (0.40 X 0.80) =1.32 ing a low regular dividend that is paid each period, the firm
2011 4.80 2.00 1.00 gives investors the stable income necessary to build conti
2010 2.40 2.00 1.00 dence in the company and the extra dividend permits them to
2009 3.60 2.00 1.00 share in the earnings from an especially good period.