Advanced Financial Management Dr. Sanjay S.

Gaikwad (SBPIM)

Advanced Financial Management

Examples on Unit No – 5

Dividend Policy and Firm Value

A] Walter’s Model:
Ex.No.1: Following are the details regarding three companies:

A Ltd B Ltd C Ltd

r = 15% r = 5% r = 10%
Ke = 10% Ke = 10% Ke = 10%
E=₹8 E=₹8 E=₹8
Calculate the value of an equity share of each of these companies applying Walter’s formula
when dividend payment ratio is (a) 25%, (b) 50%, (c) 75%

Ex.No.2: The earnings per share of a share of the face value of ₹ 100 of PQR Ltd is ₹ 20. It has a
rate of return of 25%. Capitalisation rate of its risk class is 12.5%. if Walter’s model is used –

1. What should be the optimum payout ratio?

2. What should be the market price per share if the payout ratio is zero?
3. Suppose, the company has a payout of 25% of EPS, what would be the price per share?

Ex.No.3: The EPS of ABC Ltd is ₹ 10 and rate of capitalisation 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 (a) 20%, (b) 10% or (c) 8%.

Ex.No.4: Determine the market value of equity shares of the company from the following
information.

Earnings of the company ₹ 500000

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Advanced Financial Management Dr. Sanjay S. Gaikwad (SBPIM)

Dividend paid ₹ 300000

Number of shares outstanding 100000

Price earnings ratio is 8 times

Rate of return on investment is 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.

Ex.No.5: A company has following a dividend policy which can be maximise the market value
of the firm as per Walter’s model. Accordingly, each year, at dividend time the capital budget is
reviewed in conjunctions with the earnings for the periods and alternative investment
opportunities for the shareholders.

In the current year, the firm expects earnings of ₹ 500000. It is estimated that the firm can earn ₹
100000 if the profits are retained. The investors have alternative investment opportunities that
will yield them 10% return. The firm has 50000 shares outstanding. What should be the dividend
payout ratio in order to maximise the wealth of shareholders? Also find out the current market
price of share.

Ex.No.6: From the following information supplied to you, ascertain whether the firm is
following optimal dividend policy as per Walter’s model?

Total Earnings ₹ 200000

Dividend paid ₹ 150000

Number of shares outstanding (₹ 100 each) 20000

Price earnings ratio is 12.5 times

Rate of return on investment is 15%.

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Advanced Financial Management Dr. Sanjay S. Gaikwad (SBPIM)

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 shares?

Ex.No.7: The EPS of ABC Ltd is ₹ 8 and rate of capitalisation applicable to it is 10%. The
company has before it the options of adopting a pay-out of 50% or 75% or 100%. Using Walter’s
formula, compute the market value of the company’s share if the productivity of retained
earnings is (a) 15%, (b) 10% or (c) 5%

B] Gordon Model:
Ex.No.1: The following information is available in respect of ABC Ltd

Earnings per share (EPS) = ₹ 10 (Constant)

Cost of Capital (Ke) = 10%

Find out the market price of the share under different rate of return (r) of 8%, 10% and 15% for
different payout ratios of 0%, 40%, 80% and 100%

Ex.No.2: A company has total investment of ₹ 500000 in assets and has 50000 outstanding
shares of ₹ 10 each. It earns a rate of 15% on its investment, and has a policy of retaining 50% of
the earnings. If the appropriate discount rate for the firm is 10%, determine the price of its share
using Gordon Model. What shall happen to price, if the company has a payout of 80% or 20%?

Ex.No.3: Assuming that rate of return expected by investor is 11%; internal rate of return is 12%
and earnings per share is ₹ 15, calculate price per share by ‘Gordon Approach’ method if
dividend payout ratio is 10% and 30%.

Ex.No.4: Royal Products Ltd is an established company having its shares quoted in the major
stock exchanges. Its having a paid up share capital of ₹ 50 lakhs of ₹ 10 each. Current dividend
distributed at the rate of 21% p.a. Annual growth rate in dividend expected is 3%. The expected

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Advanced Financial Management Dr. Sanjay S. Gaikwad (SBPIM)

rate of return on its equity capital is 16%. Calculate the value of company’s share based on
dividend growth model.

Ex.No.5: The shares of a chemical company are selling at ₹ 20 per share. The firm had paid
dividend at ₹ 2 per share last year. The estimated growth of the company is approximately 5%
per year.

1. Determine the cost of equity capital of the company.

2. Determine the estimated market price of the equity share if the anticipated growth rate of
the firm (a) rises to 8% and (b) fall to 3%

Ex.No.6: Calculate market price of share of a company using Walter’s Model and dividend
growth model

Earning per share ₹5

Dividend per share ₹3
Cost of capital 16%
Internal rate of return on investment 20%
Retention ratio 50%

C] MM Model:
Ex.No.1: A firm has 100000 shares outstanding and is planning to declare a dividend of ₹ 5 per
share at the end of current financial year. The present market price of the share is ₹ 100. The cost
of equity capital may be taken at 10%. Determine the expected market price at the end of the
year if,

1. Dividend of ₹ 5 is paid.
2. Dividend is not paid.

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Advanced Financial Management Dr. Sanjay S. Gaikwad (SBPIM)

Ex.No.2: A company has a capital of ₹ 1000000 in equity shares of ₹ 100 each. The shares are
currently quoted at par. The company proposes to declare a dividend of ₹ 10 per share at the end
of current financial year. The capitalisation 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 –

1. A dividend is declared?
2. A dividend is not declared?
3. Assuming that the company pays the dividend and has net profits of ₹500000 and makes
new investments of ₹1000000 during the period, how many new shares must be issued?
Use the MM Model.

Ex.No.3: Textrol Ltd has 80000 shares outstanding. The current market price of these shares is ₹
15 each. The company expects a net profit of ₹ 240000 during the year and it belongs to a risk
class for which the appropriate capitalisation rate has been estimated to be 20%. The company is
considering dividend of ₹ 2 per share for the current year.

a) What will be the market price of the share at the end of the year, if the dividend is paid
and the dividend is not paid?
b) How many new shares must the company issue if the dividend is paid and the company
needs ₹ 560000 for an approved investment expenditure during the year?

Ex.No.4: Bestbuy Ltd has outstanding 120000 shares selling at ₹ 20 per share. The company
expects to make net income of ₹ 350000 during the year ended 31st March 2020. The company is
considering dividend of ₹ 2 per share for the current year. The capitalisation rate for risk class of
this company has been estimated to be 15%. Assuming no taxes, answer the questions listed
below on the basis of the MM Dividend Valuation Model.

a) What will be the market price of the share at the end of the year, if the dividend is paid
and the dividend is not paid?
b) How many new shares must the company issue if the dividend is paid and the company
needs ₹ 740000 for an approved investment expenditure during the year?
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Advanced Financial Management Dr. Sanjay S. Gaikwad (SBPIM)

Ex.No.5: A company belongs to a risk class for which the appropriate capitalisation rate is 10%.
It currently has outstanding 25000 shares selling at ₹ 100 each. The firm is contemplating the
declaration of dividend of ₹ 5 per share at the end of the current financial year. The company
expects to have a net income of ₹ 2.5 lakhs and a proposed for making new investment of ₹ 5
lakhs. Show that under MM assumptions, the payment of dividend does not affect the value of
the firm.

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