Dividend Policy 2.pptx

Dividend policy

1. Dividend Policy Practical Questions Q1. Following are the details regarding three companies A Ltd., B.Ltd , and C. Ltd. A Ltd. B Ltd. C Ltd. Internal rate of return r 15% 5% 10% Cost of Equity capital k 10% 10% 10% Earnings per share E Rs . 8 Rs.8 Rs.8 Calculate Value of an equity share of each of these companies as per Walter’s Model when the dividend payout ratio is: 50% 75% 25% What conclusion do you draw?

2. As per Walter’s Model P = A Ltd. r = 15%, k = 10% , E = Rs . 8, r > k When Dividend payout ratio = 50% then D = 50% of 8 = 4 P = = = = Rs . 100 b) When D/P ratio = 75% then D = 75% of 8 = 6 P = = = = Rs . 90 c) When D/P ratio = 25% then D = 25% of 8 = 2 P = = = = Rs . 110 Conclusion: IRR (r) is higher than its cost of capital . The company has higher profitability and potentiality for growth. The value of its shares is highest i.e. Rs.110 when its dividend distribution is lowest.  

3. As per Walter’s Model P = B Ltd. r = 5%, k = 10% , E = Rs . 8, r < k When Dividend payout ratio = 50% then D = 50% of 8 = 4 P = = = = Rs . 60 b) When D/P ratio = 75% then D = 75% of 8 = 6 P = = = = Rs . 70 c) When D/P ratio = 25% then D = 25% of 8 = 2 P = = = = Rs . 50 Conclusion: IRR (r) is much lower than its cost of capital. The profitability is decreasing. The value of its shares is highest at Rs.70 when the dividend payout ratio is highest i.e. at 75% Hence, the company should pay higher dividend to keep its value high.  

4. As per Walter’s Model P = C Ltd. r = 10 %, k = 10% , E = Rs . 8, r = k When Dividend payout ratio = 50% then D = 50% of 8 = 4 P = = = = Rs . 80 b) When D/P ratio = 75% then D = 75% of 8 = 6 P = = = = Rs . 80 c) When D/P ratio = 25% then D = 25% of 8 = 2 P = = = = Rs . 80 Conclusion: IRR is equal to the cost of capital. The profitability is normal. The value of its share is Rs . 80 irrespective of its dividend payout ratio.  

5. DIY Q2. Details regarding three companies are given below: Sun Ltd. Moon Ltd. Star Ltd. Internal rate of return 15% 10% 8% Cost of Equity capital 10% 10% 10% Earnings per share Rs . 10 Rs.10 Rs . 10 Calculate Value of an equity share of each of these companies as per Walter’s Model when the dividend payout ratio is: 2 0% 50 % % 100% What conclusion do you draw? Ans : Sun Ltd a)Rs.140, b) Rs . 125, c) Rs . 150, d) Rs . 100 Moon Ltd. a)Rs.100, b) Rs . 100, c) Rs . 100, d) Rs . 100 Star Ltd. a)Rs.84, b) Rs . 90, c) Rs . 80, d) Rs . 100

6. Q3. 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 Walter’s model. 100% retention ( means Dividend payout 0) 50% retention ( means Dividend payout 50%) No retention ( means Dividend payout is 100%) As per Walter’s Model P = Value of the firm when 100% retention r = 15%, k = 10% , E = Rs . 5, When retention ratio = 100% then D = 0 P = = = = Rs.75 Value of the firm = 10,00,000 shares x Rs . 75 = Rs . 750 lakhs  

7. ii) Value of the firm when 50 % retention r = 15%, k = 10% , E = Rs . 5, When retention ratio = 50% then D = 2.5 P = = = = Rs.62.5 Value of the firm = 10,00,000 shares x Rs . 62.5 = Rs . 625 lakhs iii) Value of the firm when No retention r = 15%, k = 10% , E = Rs . 5, When retention ratio = 0% then D = 5 P = = = = Rs.50 Value of the firm = 10,00,000 shares x Rs . 50 = Rs . 500 lakhs  

8. Q4 . ABC ltd was started a year back with a paid up equity 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 have to find out whether the company’s dividend pay out ratio is optimal, using Walter’s formula . Earnings per share (EPS) = = = Rs . 10 Dividend per share (D) = = = Rs.8 Internal rate of return (r) = x 100 = x 100 = 10% Cost of capital (k) = = = 0.08 or 8% As per Walter’s Model P = P = = = Rs . 131.25 Concl : Using Walter’s model the firm’s pay out ratio is 80% which is not optimal. The price of share would be maximum if the dividend pay out is low.  

9. DIY Q5 . Calculate the market price of a share of ABC Ltd. under Walter’s formula Earnings per share Rs . 5 Dividend per share Rs.3 Cost of Capital 16% Internal rate of return on investment 20% Retention ratio 50% Ans : Rs . 34.37 Q6 . Bajaj Ltd. has been following dividend policy as per Walter’s model. The estimated earnings of the current year of the firm is Rs . 10,00,000. It is estimated that the firm can earn 2,00,000, if the profits are retained fully . Return on investment is 15% . The firm has 1,00,000 equity shares. Find out Dividend payout ratio in order to maximise wealth of shareholders. Current market price of share. Earnings per share. Ans : MPS = Rs . 89 ( when D= 0)

10. DIY Q7 . From the following information , ascertain whether the firm is following an optimal divided policy as per Walter’s model. Total earnings: Rs . 6,00,000 No. of shares : 60,000 Dividend paid Rs . 4,50,000 Price earning ratio: 12.5 Rate of Return : 10% % P/E= 1/k = > 1/10% => 10 times The firm is expected to maintain rate of return on fresh investments. What should be the price- earning ratio at which the dividend policy will have no effect on the value of the share. (p/e= 1/k ; k = 10percent ) Ans : P = Rs . 132.81, P = Rs . 156.25 ( when D= 0), P/E ratio = 10 times Q9 .From the following information find out as per Walter’s model : Market price per share Optimum dividend payout ratio Market value per share. Net profit for Equity shareholders = Rs . 10,00,000 Dividend per share = Rs.5 No.of shares = 1,00,000 Equity capitalisation rate = 15% Rate of return = 18% Ans : P = Rs.73.33, Optimal D = 0, Value of firm when D is zero = Rs . 80 lakhs

11. Q6. Solution r = r = (As per the question earnings of 10,00,000 is retained fully and invested in business) K = 15% E = = Since r > k the dividend payout as per Walter’s Model is 0 P = P = =  

12. Illustration : Kajol Ltd’s available information is = 15% , E= Rs.30, r = (i) 14% , (ii) 15% and (iii) 16% You are required to calculate market price of a share of the company as per Gordan model if: b= 40%, b) b = 60% and c) b=80% Calculation of Market Price of Kajol Ltd. = When b= 40% (i) r= 14% P = = = = Rs . 191.49 (ii) r= 15% P = = = = Rs . 200 (iii) r= 16% P = = = = Rs . 209.30 \  

13. = b) When b= 60% (i) r= 14% P = = = = Rs . 181.82 (ii) r= 15% P = = = = Rs . 200 (iii ) r= 16% P = = = = Rs . 222.22 c) When b= 80% ( i) r= 14% P = = = = Rs . 157.89 (ii) r= 15% P = = = = Rs . 200 (iii) r= 16% P = = = = Rs . 272.73  

14. Gordon’s Model = DIY Q 9. The rate of return expected by investors of Anjali Ltd. is 11% .Internal rate of return is 12% and earnings per share is Rs.15.Calculate the price per share by Gordon’s approach method if dividend pay out ratio is 20% and 40%. Ans. Rs.214.29, Rs . 157.89 Q10 . A company has a total investment of Rs . 5,00,000 in assets and 50,000 outstanding shares at Rs . 10 per share. It earns a rate of 15% on its investment and has a policy of retaining 50% of the earnings. If the appropriate discount rate of the firm is 10%, determine the price of its share using Gordon’s model. What shall happen to the price of the share, if the company has a payout of 80% or 20%. Ans. Rs . 30, Rs 17, Rs.15 E1=1.5  

15. Q11. The dividends of Jensen Company Ltd. are expected to grow at a rate of 25% for two years after which the growth rate is expected to fall to 5%. The dividend paid last period was Rs.2. The investor desires a 12% return. You are required to find the value of this stock. PV factor @12% is as under Year 1 2 3 Value 0.893 0.797 0.712 Gordon’s dividend growth model = Where g= growth rate = Dividend of last year = Dividend of first year (1+g) = 2 ( 1+ 0.25) = Rs.2.50 = Dividend of second year (1+g) = 2.50 ( 1+ 0.25) = Rs.3.125 = Dividend of third year (1+g) = 3.125 ( 1+ 0.05) = Rs.3.28  

16. Value of stock at the end of second year = = = = Rs . 46.86 Calculation of Present Value of Stock Price (P.V. factor @12%) Rs . First year D1 (2.50 X 0.893) 2.23 Second year D2 (3.125 X 0.797) 2.49 P2 (46.86 X 0.797) 37.34 Present Value of stock 42.06 Q12 Max Ltd provides you with the following information: Growth rate =2% Dividend payout = 40% Face value of shares = Rs.10 Return on Equity capital 15% Find out price per share as per Gordon’s model Ans : Rs . 31.38  

17. Q13. Majestic Ltd. is foreseeing a growth rate of 12% per annum in the next two years. The growth rate is likely to fall to 10% for the third year and the fourth year. After that the growth rate is expected to stabilise at 8% per annum. If the last dividend was Rs . 1.50 per share and the investor’s required rate of return is 16% determine the current value of its equity share. The PV factors at 16% are Year 1 2 3 4 5 Value 0.86 0.74 0.64 0.55 0.48 D1= 1.68 D2= 1.88 D3= 2.06 D4= 2.27 D5= 2.49 P4= = 31.125 P PPPV Rs PV PV in Rs . Ans : Rs . 22.33 D1= D0 ( 1 + g) => 1.50 ( 1+ 0.12) => 1.68 0.86 1.45 D2= D1 ( 1+ g) => 1.68 ( 1+ 0.12) => 1.88 0.74 1.39 D3 = D2 (1 + g) => 1.88 ( 1 + 0.10) => 2.06 0.64 1.32 D4 = D3 (1 + g) => 2.27 0.55 1.25 D5 = D4 (1+g) = > 2.45 - P4 = 2.45/0.16-0.08 31.00 0.55 17.05 Value of stock 22.46 Q14. The required rate of return of investor’s is 15%. Zee Ltd. declared and paid annual dividend of Rs . 3 per share. It is expected to grow @20 % for the next 2 years and 10% thereafter. Compute the price at which company’s share should sell. P.V. Factor @ 15% for Year 1 = 0.8696 and Year 2 = 0.7561 Ans : Rs . 78.23  

18. (1+g) = 3 ( 1+ 0.2) = Rs . 3.6 (1+g) = 3.6( 1+ 0.20) = Rs . 4.32 (1+g) = 4.32 ( 1+ 0.10) = Rs . 4.75 = = Rs . 95 Calculation of PV of Dividend and Price PV @15% First Year (3.6x 0.8696) = 3.13 Second Year ( 4.32x 0. 7561) = 3.27 Second Year ( 95 x0.7561) = 71.83 Value of stock ( Rs ) 78.23  

19. COMPUTATION OF MARKET PRICE OF A SHARE AS PER MM MODEL Where, = Prevailing market price of a share = Market price of a share at the end of period one. = Dividend to be received at the end of period one. =Cost of equity capital. The number of shares to be issued to implement the new project is ascertained with the help of the following formula: Where Change in the number of shares outstanding during the period. I = Total investment amount required for capital budget. E = Earnings or Net Income of the firm during the period . n = No. of shares outstanding at the beginning of the period. = Dividend to be received at the end of period one. = Market price of a share at the end of period one.  

20. MM MODEL Illustration: Nestle Ltd. belongs to the same risk class. The capitalisation rate is 10% . The company has 1,00,000 shares selling at Rs . 100 each. The firm is contemplating a dividend of 6% per share at the end of current year which has just begun . Based on M.M. Model: What will be the price of a share at the end of the year if dividend is not declared. What will be the price of the share if dividend is declared. Assuming that the company pays dividend and has a net income of Rs . 10,00,000 and makes new investment of Rs . 20,00,000 during the period how many new shares should be issued. Calculation of Market Price i) When dividend is not declared 100 = = 110= + 0 = = 110 ii) when dividend is declared: 100 = 110= + 6 = 104  

21. Calculation of no. of shares to be issued I= 20,00,000 E= 10,00,000 Existing shares n= 1,00,000 D1= 6 When dividend is declared = = 15,385 shares When dividend is not declared = = 9,091 shares  

22. Q 15. M Ltd. belongs to a risk class for which the capitalization rate is 10%. It has 25,000 outstanding shares and the current market price is Rs . 100. It expects a net profit of Rs . 2,50,000 for the year and the board is considering dividend of Rs . 5 per share. M Ltd. requires to raise Rs . 5,00,000 for an approved investment expenditure. Show , how does the MM approach affect the value of M Ltd. if dividends are paid or not paid. a) Calculation of Market Price per share under MM Model i) When dividend is declared: 100 = 110= + 5 = Rs.105 ii) When dividend is not declared 100 = = 110= + 0 = = Rs.110 I = 5,00,000 E= Rs . 2,50,000 D= Rs.5 no of shares given = 25,000 5,00,000 – (2,50,000- 25000x 5)/ 105= 5,00,000- 1,25,000/ 105= 3571 shares or 3500 shares 5,00,000- ( 2,50,000 – 25,000 x 0)/ 110 5,00,000 – 2,50,000 / 110= 2272 shares  

23. b) Calculation of number of new shares to be issued ( Rs . In Lakhs) ` Particulars Dividend is declared Dividend is not declared Net Income ( Earnings) Less: Dividend paid Retained Earnings New Investments Amt to be raised by issue of new shares (a) Market price per share (b) No. of new shares to be issued (a)- (b) c) Verification of MM Dividend Irrelevancy Existing Shares New shares issued Total no of shares at the year end (i) Market price per share (ii) Total MV of the firm at the end of year (i) X (ii) 2,50,000 1,25,000 1,25,000 5,00,000 3,75,000 Rs . 105 3,571 25,000 3,571 28,571 Rs . 105 Rs . 30 lakhs 2,50,000 - 2,50,000 5,00,000 2,50,000 Rs . 110 2,273 25,000 2,273 27,273 Rs . 110 Rs . 30 lakhs

24. Q 16 . Ratna Ltd. has 1,60,000 shares outstanding. The market price of shares is Rs . 10 each. The company expected a net profit of Rs . 4,80,000 during the year end and a capitalised rate is 20%. The company is considering dividend of Rs . 1 per share for the current year at the end of the year. What will be the price per share If dividend is paid. If dividend is not paid. Ans : i) Rs 11, ii) Rs . 12 Q17. Astha Ltd. has outstanding 2,40,000 shares selling at Rs . 20 per share. The company wants to earn net profit of Rs . 10,00,000 during the year end. The company decided to pay the dividend of Rs . 3 per share at the end of the year. The capitalization rate of risk class of the company is estimated at 15%. Find out the following: Price of the share if the dividend is paid. Price of the share if the dividend is not paid. How many new shares company must issue if the dividend is paid for the investments of Rs . 12,00,000. Ans : i) Rs . 20, ii) Rs . 23 iii) 46,000 shares

25. Q 18 . Shyam Ltd. had 1,00,000 equity shares of Rs.10each outstanding on 1 st January, 2017. The shares are currently being quoted at par in the market. In the wake of the removal of the dividend restraint , the company now intends to pay a dividend of Rs . 2 per share for the current financial year. It belongs to a risk class whose appropriate capitalization rate is 15% . Using MM Model and assuming no taxes , ascertain price of the company’s shares as it is likely to prevail at the end of the year When dividend is declared When dividend is not declared Also find out the number of new equity shares that company must issue to meet its investment needs of Rs . 4,00,000 when the dividend is paid and when the dividend is not paid. The earnings per share works out @Rs.2.20. Also verify MM’s irrelevancy theory. Ans : i) Rs . 9.5 ii) Rs . 11.5 iii) 40,000 shares