Problems on Dividend policy

1. The following information is available for Avanti Corporation . (Prasanna Chandra 535, Walters)
Earnings purchase = Rs. 4/-; Rate of return on investment = 18%; Rate of return required by share holders = 15%;
What will be the price per share as per the Walter model. If the payout ratio is 40%; 50% & 60%?

2. The following data is available for Parkson company (Prasanna Chandra 537, Exercise Problem; Walters)
Earnings per share = Rs. 3/-; Internal rate of return = 15%; Cost of capital = 12%.
If Walters valuation formula holds what will be the price per share. If dividend payout ratio is 50%; 75% & 100%?

3. The earnings per share of a company is Rs. 8/- & rate of capitalization applicable is 10%. The company has
before it, An option of adopting
i) 50% ii) 75% iii) 100% Dividend payout ratio.
Compute market price of companys quoted shares as per Walters model. If it can earn a return of 15%, 10% &
5% on its retained earnings.

4. XYZ Ltd. has rate return of (i)16% (ii)10% (iii)8% and its D.P.O ratio is (i)40% (ii)60% (iii) 80%
The EPS of the company is Rs. 10/- and the capitalization rate applicable is 12%. Calculate price of the companys
share as per Walter model.

5. (Gordon Model Problems) The following information is available for Kavitha Musicals. (Prasanna Chandra 536)
EPS=Rs. 5/-
Rate of return required by share holders=16%
Assuming that the Gordon valuation model holds, what rate of return should be earned on investment ensure
that the market price is Rs. 50/- When the dividend payout is 40%.

6. The following data are available for Rajdhani Corporation.
EPS=Rs. 8/-
Internal rate of return =16%; Cost of capital = 12%
If Gordons valuation formula holds what will be the price per share when the D.P.O is 25%; 50% & 100%.

7. CS 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. 6.4 as Dividend per share the rate of
capitalization appropriate to the risk class to which a company belongs is 9.6%.
(i) Based on MM approach calculate market price of the share of the company when the dividend is declare d&
dividend is not declared.
(ii) How many new share are to be issued by the company if the company desires to investment budget of 3.2
crores Rs. by the end of year assuming net income for the year will be Rs. 6 crores.

8. (MM, SKG 9.23) ABC 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 declaration of a dividend of Rs. 10/- share at the end of current
financial year. The capitalization rate for the risk class to which company belongs is 12%. What will be the market
price of the share at the end of the year. If
i) Dividend is not declared
ii) If dividend is declared.

9. Rouna company belongs to a risk class of which the appropriate capitalization rate is 10%. It currently has
1,00,000 share selling at Rs. 100 each. The firm is contemplating the declaration of Rs. 6/- dividend of the end of
current fiscal year, which has just began.
Answer the following questions based on MM model assume that no taxes prevail.
a) What will be the price of shares @ the end of a year if dividend declared and if dividend not declared.
b) Assuming that the firm pays dividend, has a Net income of Rs. 10,00,000 and makes a new investment of Rs.
20,00,000 during the period how many new share have to be issued.



Assignments
1) (Walter; Prasanna Chandra 524) Comment on the effect of the dividend policy for the given details
Growth Firm: r>k Normal Firm: r=k Declining Firm: r<k
r=20% r=15% r=10%
K=15% K=15% K=15%
E=Rs 4 E=Rs 4 E=Rs 4
If D=Rs 4 If D=Rs 4 If D=Rs 4
If D=Rs 2 If D=Rs 2 If D=Rs 2

2) (Gordon; Prasanna Chandra 526) Calculate price of the share using Gordon model and comment on the
impact of dividend policy
Growth Firm: r>k Normal Firm: r=k Declining Firm: r<k
r=20% r=15% r=10%
K=15% K=15% K=15%
E=Rs 4 E=Rs 4 E=Rs 4
If b=0.25 If b=0.25 If b=0.25
If b=0.5 If b=0.5 If b=0.5


3) (Walters HB155) Given the following information about ZED Ltd., show the effect of the dividend policy on the
market price of its shares, using the Walters model:
Equity capitalization rate (Ke) =12%
Earnings per share (E) =Rs 8
Assumed return on investments (r) are as follows: 1) r=15% 2) r= 10%

4) (Gordon HB 157) If Ke=11% and E=Rs 15, calculate the stock value of YX Ltd for 1) r=12%; 2) r=11%; 3) r=10%

5)(MM HB 159) ABC ltd, belongs to a risk class for which the appropriate capitalization rate is 10%. It currently
has outstanding 5,000 shares selling at Rs 100 each. The firm is contemplating the declaration of dividend of Rs 6
per share at the end of the current financial year. The company expects to have a net income of Rs 50,000 and
has a proposal for making new investments of Rs 1,00,000. Show that under the MM hypothesis, the payment of
dividend does not affect the value of the firm.

6) (Walter, SKG 9.7) The following information is available in respect of a firm:
Capitalisation rate =10%; EPS= Rs 50
Assumed rate of return on investments:
1) 12% 2) 8% 3) 10%
Show the effect of dividend policy on market price of shares applying Walters formula when dividend pay out
ratio is (a)0% (b)20% (c) 40% (d) 80% (e) 100%

7) (Gordon, SKG 9.10) The following information is available in respect of the rate of return on investment (r), the
cost of capital (k) and earning per share (E) of ABC Ltd
Rate of return on investment (r) = (i) 15%; (ii) 12%; (iii) 10%
Cost of capital (k) = 12% ; Earning per share (E) = Rs 10
Determine the value of its shares using Gordons Model assuming the following
D/p ratio (1-b) Retention ratio (b)
(a) 100 0
(b) 80 20
(c) 40 60



8) (Gordon, SKG 9.11) The following information is available in respect of return on investment (r), the cost of
capital (ke) and earning per share (E) of XYZ Ltd.
r=10% ; E = Rs 40
Determine the value of its shares using Gordons Model, assuming the following:
D/p ration (1-b) Retention ratio (b) Cost of equity (ke)%
(a) 20 80 20
(b) 40 60 18
(c) 60 40 16
(d) 80 20 14

9) (Gordon, SKG 9.12) A company is expected to pay a dividend of Rs 6 per share next year. The dividends are
expected to grow perpetually at a rate of 9%. What is the value of its share if the required rate of return is 15%?

10) (Gordon, SKG 9.12) The current price of a companys share is Rs 75 and dividend per share is Rs 5 calculate
the dividend growth rate, if its capitalisation rate is 12 percent.

11) (Gordon, SKG 9.12) The current price of a companys share is Rs 200. The company is expected to pay a
dividend of Rs 5 per share next year with an annual growth rate of 10%. If an investors required rate of return is
12%, should he buy the share?

12) (Gordon, SKG 9.13) The book value per share of a company is Rs 145.5 and its rate of return on equity is 10%.
The company follows a dividend policy of 60% pay out. What is the price of its share if the capitalisation rate is
12%?

13) (Walters, SKG 9.21) The earnings per share of company are Rs 8 and the rate of capitalisation applicable to
the company is 10%. The company has before it an option of adopting a payout ratio of 25% or 50% or 75%. Using
Walters formula of dividend payout, compute the market value of the companys shareif the productivity of
retained earnings is (i) 15% (ii) 10% and (iii) 5%

14) (Walters, SKG 9.22) The following information relates to XYZ Ltd.:
Paid up equity capital Rs 20,00,000;
Earnings of the company 2,00,000
Dividend paid 1,60,000
Price earning ration 12.5
Number of shares outstanding 20,000
You are required to find out whether the companys dividend pay out ratio is optimal, using Walters Model.

15) (MM, SKG 9.23) ABC Ltd has a capital of Rs 10 lakhs in equity shares of Rs 100 each. The shares are currently
quoted at par. The company proposes declaration f a dividend of Rs 10 per share at the end of the 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:
(i) a dividend is not declared?
(ii) a dividend is declared?
Assuming that the company pays the dividend and has net profits of Rs 5,00,000 and makes new investments of
Rs 10 lakhs during the period, how many new shares must be issued. Use the MM model.

To gain more knowledge and subject matter expertise, You can also solve the problems from I M Pandey and
Khan and Jain.;)