504

Worked-out Drobleno
WALTER'S MODEL
Problem 1

Anil Company Ltd. has capitalisation rate (K) of 10%. Its earning per share is 20. The
declares R 10 as dividend. According to Walter's Model, you are required to calculate company
assuming 20% returns on investment. share prica
Solution
Where,
D+ K (E - D) P - Market price of each equity share
P = E = Earnings per share, i.e., ? 20
D = Dividend per share, i.e., ? 10
0-20
10
0-10
(< 20 - 10) E-D =Retained earnings per share rate of
0-10 = Rate of return on
20-7 10) =10
investment, i.e., 0-20
=300. Ke =Cost of capital i.e., 0-10
Problem 2
From the following data, determine price per share
according to Walter's Model and comment :
Particulars Ram & Co. Shyanm &Co.
Earnings per share 12
Cost of capital 12
Return on investment 12% 12%
15% 15%
Dividends per share ?8 75
Solution
Price of equity share :
I 0-15
D+ (E- D) 8+
0-12
(12 - 8)
Ram & Co. : P = 8 + 1-25 × 4
Ke 0-12 0-12 =108-33
5 +0-15
0·12
12 -5)
Shyam &Co. :P = =114-58
0-12

Comment : According to Walter's Model, value of share price is maximised whenr> K. with low
pay-out ratio. dividend
In the above problem Shyam & Company has maximised share price because the
per share is low.
company's dividend
 505

Problem 3

The following information is available in respect of a firm:

Earnings per share (EPS) 40
Capitalisation rate (K) 10%
Assumed rate of return on investment (r) : () 13% ; (i) 10%; (ii) 8%.
You are required to show the effect of dividend payment on the market price per share using
Walter's Model, when dividend pay-out ratio is : (a) 0%, (0) 25%, (c) 37-5%, (d) 50%, (e) 75%,
(f) 100%.
Solution

As per Walter's Model, market price of a share (P) is given by,

Where,
D+ (E - D) D =Dividend per share, i.e., Earnings per share x
P= Dividend pay-out ratio
Ke = The rate of return on investmernt
K,= Cost of capital i.e., 0-10
E =Earnings per share i.e., ? 40
Value of Share Price
Growtlh fir1n Normal fin Declining firm
r> Ke r= Ke r<K
13 > 10% 10 = 10% 8 < 10%

(a) When DPR 0%:

Dividend per share =
Earnings per share x
Dividend pay-out ratio
0-13 0-10 0-08
0+ ( 40 0) 0+ (? 40 0) 0+
0-10
(? 40 0)
0-10 0-10
P= P= P=
0-10 0-10 0-10
= 520 = 400 =320
() When DPR 25% :
Dividend per share =
Earnings per share x
Dividend pay-out ratio
i.e., 40 x 25% = 10
0-08
7 10 + 0-13 (? 40 R 10) 7 10 + 0-10 40 10) 7 10 + ( 40 10)
0-10 0-10 0-10
P= P= P=
0-10 0-10 0-10
= 490 = 400 =340
 Grooth firm Nonnal fim
r> K r= K Declining firm
13 > 10% 10 = 10% r< K
8< 10%
(c) When DPR 375% :
0·13
R 15 + ( 40 R 15) 15 +
0-10
010
0-10
(? 40 ? 15) ? 15 + 0-08
P P= 40 -? 15)
0-10 P= 0-10
0·10
= 475 0-10
- 400
= 350
() When DPR 50%:
0-13
20 + (? 40 R 20) 0-10
P=
0-10 20 +
0-10
( 40 20) 20 + 0-08 (? 40 - R 15)
P= 0-10
0-10 P=
0-10
= 460 = 400 0-10
When DPR 75% :
=?360
(e)
0-13
30 + (R 40 - 30) 30 +
0-10
0-08
0-10 (? 40 30) 730 +
P= 0-10 40 30)
0-10 P= 0-10
0-10 P=
= 430 0-10
= 400
=7380
) When DPR 100%:
0-13
40 + (? 40 40) 40 + 0-10 (? 40 40) 40 +
0-08
P=
0-10 0-10 0-10
(? 40 40)
P= P=
0-10 0-10 0-10
=400 = 400 = 400
Comments :
(1) When rate of return (r) is higher than cost of capital (Ke),
that firm is treated as
cases if dividend pay-out ratio increases, then value per share will be decreases.growth firm. 1n that
The market value
of shares (? 520) is highest when D/P ratio is zero, i.e., the firm
retains its entire earnings. When all
earning are distributed, i.e., D/P ratio is 100%, then its market value of share shows the lowest price
(? 400).
(2) When rate of return (r) is exactly equal to the cost of capital (K) then that firm will be
treated as
normal firm. It can be observed here in spite of change in the dividend pay-out ratio value per share
has remained unaltered. It is a matter of indifference whether the firm retains whole of the profits or
distribute dividends. So, there is no optimum dividend policy.
(3) When the firm is a declining firm, where r < Ke D/P ratio and the value of share are correlated
positively. In this case, dividend pay-out ratio increases, the market value of shares also increases
and vice versa. Value per share is the maximum when dividend pay-out ratio is 100%. Therefore
optimal dividernd policy for the firm is to pay more dividends and retain less.
 507

Problem 4
From the following information, state whether the firm's dividend policy as per Walters Model is
optimum :

Earnings of the firm Z1,00,000

Dividend paid R75,000
Number of shares 50,000
Per share value 10
Price earning ratio 8 [C.u,,M.Com]
Solution
75,000 = 0-75
Dividend pay-out ratio = 1,00,000
1,00,000
=2-00
E = Earnings per share = 50,000
1 1
K, = Cost of capital = = 0-125
8
Price earning ratio
Earning per share 2
= Rate of return = = 0:2
Per share value 10

D =Dividend per share E x Dividend pay-out ratio = 2x O-75 = 1-50

Dividend paid ?75,000 =1:50
Or,
No. of shares 50,000
We know,
D+ (E- D)
P =
K
K¹
0-20
1-50 + (2-1-50)
0-125
or, P =
0-125

150 + 1-6 (0-5) 2-30

=7 18-40
or, P =
0-125 0-125
When pay-out ratio = 0
0-20
0+
0-125
(2-0) 0+1-6 x 2 3-2
P= =25-6
0-125 0-125 0-125

Since r > Kp dividend pay-out ratio should be 0. When D=150 (present position), value of share
is 18-40 and when D =0, value of share will be? 25-6.
So, it may be concluded that the firm's dividend policy is not optimum. It will be optimum when
D=0.
 508

Problem 5

Erom the following information of ABCCompany Ltd.

Model : determine equity share price as per Walters
Eamings per slhare 10.
Dividends per share 6.
Cost of equity capital 15%.
Required rate of return on investment 20%.
Solution
D+ 0·20
(E - D) 6+ (? 10 6)
P= 0-15 76+R 5-33 11-33
Ke 0-15 0-15 0-15
=75-53.
Problem6
Z Co. Ltd. has an investment of
10,00,000in
the conmpany is 16%. Pay-out ratio is 80%, costequity shares of 100 each. The profitability rate of
as per Walter's Model ? Do you consider the
of capital is 10%. What will be the price per share
given pay-out ratio as optimum ? (C.u., B.Com. (Hons.) "09]
Solution
As per Walter's Model, market price of a share (P) is given
r
by,
D+
P =
K, (E - D)
Where,
Ke D = Dividend per share i.e., Earningper share x Dividend

7 12-80 +
0-16 pay-out ratio = (100 x 16%) x 80% = 12-80
0-10
(? 16 - 12-80) = The rate of return on investment= 16% i.e., 0-16
P
0-10
Ke = Cost of equity capital or capitalisation rate
7 12-80 + 5-12 10% i.e., 0-10
0-10
= 179-20 = Earnings per share =(16% of 100) i.e., 16
Price per share as per Walter's Model = 179-20
When r > Kp, that firm will be treated as growth firm. For such firm, the optimum dividend
pay-out ratio would be zero. This step resultsin the maximisation of the market value of itsshare.
In such situation, the price per share will be as follows:
0-16
0+ (16 - 0) x? 16
0-10 5 7 25-6
P= =256
0-10 0-10 0-10
Hence, we can not consider the given pay-out ratio as optimum.
 509

Problem 7

A
company has 1,0,000 equity shares of R10 each fully paid up.The company expects its earningS
at 12,00,000 and cost of capital at 10% for the next financial year. Using the Walter's Model,
what dividend policy should be recommend when the rate of return on investment of company is
estimated at 8% and 12% respectively?
What will be the price of equity share |when the dividend pay-out ratio is : () 0%, (ii) 25%,
(C.u,,M.Con.]
bi) 50%, (iv) 100%] if your recommendations are accepted ?
Solution Where,
R12,00,000 P = Price per equity share
Earnings per share (E) = 1,00,000 D= Dividend per share = EPS x D/P ratio
25
= 12 = (i) 12 x0 =0; (ii) 12 x -3;
100
50 100
According to Walter's Model: = (iii)12 x
100
=6;(iv) 12 x
100
= 12
r
D(E- D) 7 12,00,000
E = Earnings per share = 1,00,000 =12
P=
K.
K,= Cost of capital = 10% = 0-10
= 8% ;
= Internal rate of return on investment
12% or, 0-08 ; 0-12

Stateinent Showing Calculation of Market Price per Share (MPS)

MPS when MPS when
Particulars r= 12%
r= 8%
(r<K) (r> K)
Items :
0-08 0-12
0+ 0.10 (12 -0) 0+
0-10
(12- 0) 96 144 (H)
() 0-10 0-10
0-08 0-12
3+ (12- 3) 3 0-10 (12-3)
0-10 102 138
ii) = 0-10
0-10
0-08 0-12
6+ (12 - 6) 6+ 0-10(12-6)
0-10 108 132
(iii) = 0-10
0-10
0-08
0-10 (12-12) 0-12 12)
12 + 12 + 0-10(12 - 120
120 (H)
(tv) = 0-10 0-10

Optimum dividend policy recommended will be:

MPS will be the highest 120.
(1) When r<Kp, the optimal D/P ratio will be 100% and
will be the highest i.e., 144.
(2) When r> Ko, the optimal D/P ratio will be 0% and the MPS
 510

Problem 8
Nilanjana Ltd. supplies you the following
the ompany under Walter's Model. information. Determine the market price per sha
(a) Net earnings of the company
? 50,00,000
(0) No. of equity shares outstanding
(c) Dividend paid 10,00,000
(d) D/P ratio 30,00,000
(e) Price carning ratio (P/E ratio) 66/3%
() Rate of return on 15-3846
investnnent
If you are not satisfied with the 11-3759%
current dividend policy, what
pay-out ratio ? should be the
Solution optimum dividend
EPS E= 50,00,000 =5
10,00,000
DPS =D= 30,00,000 3
10,00,000
Ke (cost of capital) - 1 1
= 0.065
P/E ratio 15-3846
According to Walter's Model :
D+(E -D)
P Ke
e

3+ 0-11375
0-065 (5 3) 3 + 1-75(2)
0-065
3+3-50 6-50
0-065 0-065 =7 100
0-065
The above dividend policy is not
then optimal. As r > K, the optimal dividend
0-11375
pay-out ratio is 0%,
0 +
0-065 (5 - 0)
8-75
P
0-065 = 135 ..P= 135.
0-065
Problem 9
Simran Company Ltd. expecting 10% returns on total assets 50
shares of 20,000. The Board of Directors of the company have lakh. The company has outstanding
decided to pay 40% of earnings as
dividend. The rate of returns required by shareholders is 12-5%,
investment is 15%. rate of returns expected on
You are required to determine the price of shares using Walters Model. Are you satisfied wi
current dividend policy of the company ? If not why?
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Solution

Computation of share price under Walter's Model nceds earning per share (EPSs) and dividend per
share(DPS). So, before determining share price it is necessary to calculate EPS and DPS.
Total earnings
(1) Calculation of EPS = No, of
shares outstanding
10
50,00,000 x 100
- 25 per share
20,000 shares
40
Dividend per share (40% of earnings) =EPS x 100
40
= 25 x = 10per share
100
D+ K (E-D)
Where,
P =
K. D = Dividend per share i.e., 10
0-15
7 10 + ( 25 - 10) = The rate of return on investment i.e., 0-15
0-125
0-125 K, = Cost of capital i.e., 12-5% = 0-125
10 + 18
E = Earning per share i.e., ? 25
? 28
-=224
0-125 0-125
No, we are not satisfied with the company's current dividend policy, because according to Walter's
Model when r > Ke, the optimal dividend policy is zero.
Problem 10

The following information is available for Asit Company :

Earnings per share 20

Dividend pay-out ratio 50%

Price earning ratio (P/E) 10
Internal rate of return 15%

Determine share price using Walter's Model and give optimaldividend policy to the company.
Solution
0-15
D+ K (E-D) ? 10 +
0-10
(? 20-7 10) 725
P= =250
0-10 0-10
K¹
Optimum dividend ratio for the company is 'zero %.

Working Notes:
1 1
= 0-10.
(1) Calculation of cost of equity i.e, Ke = Price ea ning ratio 10

(2) Dividend per share = EPS x Dividend pay-out ratio

50
=20 x =710.
10
 512

Problemn 1

The rnings per share of acompany is 8 and the

rate of
wmpy has before it, an option of adopting 50%o, 75% and capitalisation
100%
applicable is 10%, Tho
Compute the narket price of the company's quoted shares as per dividend pay-out ratio.
a retun of : (a) 15% 0) 10% and (c) 5% on its
retained carnings.
Walter's Model if it can earn
Solutlon

() DP ratio - 0.50 (ii) D/P ratio = 0-75

Growth
firm (a) r = 0-15 (iii) D/P ratio = 100% = 1
D+(E - D)
P
K
0-15
4+
(? 8- 4) 0-15
0-10 76+ (?8- 6) 8+
0-15
P
0-10
0-10 8-?8)
0-10 P=
0-10
Normal
firm =100 =90 = 80
0-10

() r = 0-10
0-10 0-10
4+ (? 8- 4) 6+ (?8 6) 0-10
0-10 0-10 8+ 8- 8)
P= P= 0-10
0-10 P=
0-10 0-10
Declining
firm = 80 =80 = 80
(c) r = 0-05
0-05 0-05 0-05
4+ (?8- 4) 6+ (?8 6)
0-10 0-10 8+
0-10
R8-7 8)
P= P P=
0-10 0-10 0-10
=60 =770 =80

Problemn 12

The following figures are collected from the annual report of XYZ Ltd. :
< 30 lakh
Net profit
? 100 lakh
12% preference share
3lakh
Number of equity shares
20%
Return on investment
16%
Cost of capital
at 42 using
What should be the approximate dividend pay-out ratio so as to keep the share price [CA., Final 05]
WaltersModel?
 513

Solution
Where,
Model,
As per Walter's P=Market price per share i.e., ? 42
K (E - D)
D +
E= Earnings per share, i.e., ?6
P=

30,00,000
Net profit
12,00,000
LS: Preference share dividend
18,00,000
Earnings available for equity shareholder
Earning available for cquity shareholder 18,00,000
=76
EPS = 3,00,000
No. of equity share
Cost of capital (Ke) = 0-16
r= The rate of return on investment i.e., 20% = 0-20
Let, D/P ratio is x
. D =Dividend per share =?6 x x =? 6x
D+
K,
(E- D)
P=
Ke
0-20
6x + (6- 6x)
0-16
or, 42 = 0-16

Or,
6-72 = 6x + 7-50 7-50x

Or, 1-5x = 0-78

or, X = 0:52

So the required dividend pay-out ratio is 52%.

Problem 13
of 137-80. Its return on equity is 15% and it follows
A company has a book value per share
opporturnity cost of capital is 18%,what is the price
a policy of retaining 60% of its earnings. If the [C.A., Final (May) '02]
of the share today?
 514

Solution

As per Walter's Model, Where,

r
D+ (E - D) P Market price per share
P=
K = The rate of return = 15% i.e., 0-15
Retained earnings = 60% K = Cost of capital = 18% i.e., 0-18
E =R 137-80 x 0-15 =20-67
Dividend pay-out ratio = 40%
Dividend per share = Earnings per share x Dividend pay-out ratio
= 20-67 x 0-40 = 8-268
0-15
8-268 + (20-67 - 8-268)
0-18
.. P =
0-18
8-268 + 10-334 18.602
= 103-34
0-18 0-18

The price per share today = 103-34.