6 - Dividend - DividendPolicy - FM - Mahesh Meena
6 - Dividend - DividendPolicy - FM - Mahesh Meena
6 - Dividend - DividendPolicy - FM - Mahesh Meena
Presented by –
Problems
Solution:
2. Beta Industries has net income of $5,000,000 and it has 1,000,000 shares
of common stock outstanding. The company’s stock currently trades at
$50 a share. Beta is considering a plan where it will use available cash to
repurchase 25 percent of its shares in the open market. The repurchase is
expected to have on effect on either net income or the company’s P/E
ratio. What will be its stock price following the stock repurchases?
Solution:
Solution:
NI = $40lakhs; Debt Ratio= 60%; Capital Budget 18M Debt Ratio = 60%
therefore Equity is 40%Distributions = Net Income – [(Target Equity Ratio) x (Total
Capital Budget)]
Distributions = 18M – [(.40)x(18M)] = 10.8M
Dividend Payout = 10.8/ 18 = 0.6=60%
Note that the projects cost of capital varies because the projects have
different levels of risk. The company’s optimal capital structure calls for 50
percent debt and 50 percent common equity. Welch expects to have net
income of $9,580,000. IF Welch bases its dividends on the residual model,
what will it payout ratio be?
Solution:
Solution:
Profit Rs 3,40,000
Less: Interest on debentures (0.12) 60,000
Earning before taxes 2,40,000
Less: taxes (0.35) 84,000
Earning after taxes 1,56,000
Number of equity shares (Rs 10 each) 40,000
Earning per share 3.9
Ruling market price 39
P/E ratio (price/EPS) (times) 10
The company has undistributed reserves, Rs. 6, 00,000. It needs Rs. 2, 00,000
for expansion which will earn the same rate as funds already employed.
You are informed that a debt-equity ratio higher than 35 percent will push
the P/E ratio down to
(i) If the additional funds are raised as debt; and
(ii) If the amount is raised by equity shares (at current market price).
Solution :
Solution:
Determination of interest:
Financing option 2 has highest EPS hence the best option out of three options available.
Dividend Policy
1. Secure Ltd.’s has earnings per share is Rs 5. The expected rate of return by the
shareholder’s is 15%. Assuming the Gordon valuation model holds, with a market
price of Rs 120 per share, calculate the rate of return that should be earned to
ensure a market price of Rs 120/share, with 40% dividend pay-out ratio.
Solution:
P = E(1-b) / ( K- br )
Where,
P = Price
E = Earning per share
b = Retention Ratio
K = Cost of capital
r = rate of return
Here,
P = Rs 120
E = Rs. 5
b = 1 – 0.4 = 0.6
K = 0.15
Solution:
b = 0.7
P = 18 (1 – 0.7 ) / ( 0.14 – (0.7)(0.17) )
= Rs. 257.14
ii) Payout Ratio = 60 %
b = 0.4
P = 18 ( 1- 0.4 ) / ( 0.14 – (0.4)(0.17) )
= Rs. 150
b=0
P = 18 ( 1- 0 ) / ( 0.14 – 0 )
= Rs. 128.57
3) A company has a total investment of RS 8,00,000 in assets and the total number of
equity shares outstanding is 80,000 shares at Rs 10 per share (face value). The
company earns a return of 18% on its investments and retains 40 % of the total
earnings. Assuming a discount rate of 12% applicable to the firm, determine the
price per share for the firm using the Gordon’s model. Also calculate the price per
share in case of 80 % and 20 % pay-out ratios.
Solution:
i) Payout Ratio = 60 %
b = 0.4
P = 1.8 (1- 0.4 ) / ( 0.12- (0.18)(0.4) )
= Rs. 22.5
b = 0.2
P = 1.8 (1- 0.2) / (0.12 – (0.18)(0.2) )
= Rs. 17.14
b = 0.8
P = 1.8 (1 – 0.8) / (0.12 – (0.18)(0.8) )
= Rs. 15
4. X company earns Rs 10 per share, is capitalized at a rate of 15 percent and has a
rate of return on investment of 15 percent.
According to Walter’s model, what should be the price per share at 25
per cent dividend payout ratio? Is this the optimum payout ratio
according to Walter?
Q4.
P = D/k + {r*(E-D)/k}/k,
Ans: E = Rs.10/ share
D= 25% of EPS = 2.5
K= 15%
R= 15%
P= (2.5/0.15)+(0.15)*(7.5)/((0.15)*(0.15))
P = 66.67
5. CSA Ltd. has 8,00,000 equity shares outstanding of the beginning of the year
2007. The current market price per share is Rs. 120. The board of directors
of the company is contemplating Rs. 8 as dividend per share the rate of
capitalization appropriate to the risk class to which a company belongs is
9.5%.
(i) Based on MM approach, calculate market price of the share of the
company when the dividend is declared & dividend is not declared.
Solution:
Price of the share when dividends are paid
P1 = P0 (1+Ke) – D
= 120 (1 + 0.095) – 8
= 131.4 – 8 = 123.4
Price of share when dividends are not paid
P1 = P0 (1 + Ke) – D
= 120 (1 + 0.095) – 0
= 131.4
Calculate the value of its shares using Gordon’s Model with the following
assumptions:
D/p ration (1-b) Retention ratio (b) Cost of equity (ke)%
(a) 25 75 18
(b) 45 55 15
(c) 65 35 13
(d) 85 15 12
Solution:
a. P = (EPS * (1 – b)) / (ke – b * r)
= (50 * 0.25) / (0.18 – 0.75 * 0.12)
= 138.89