Dividend Policy
Dividend Policy
Dividend Policy
Dividend Policy
There are 4 models in Dividend Policy. These are as follows:-
Walter model
Gordon model
MM model
Traditional Model: According to this App. High D/P ratio, Highly effected on Share Price.
(
Where, P = Price m = multiplier D = Dividend per share E = Earning per share
)
III.
b. r < ke , Direct relation b/w Price & D/P ratio. c. r = ke , No relation b/w Price & D/P ratio. Gordon Model
( ( ) )
II.
Walter Model:
( )
Where, P = Current market price per share. E = Earning per share b = Retention ratio 1-b = D/P ratio Ke = Required rate of return br = growth rate Conditions: a. R > ke , Inverse relation b/w Price & D/P ratio but direct relation b/w price & retention ratio. b. R < ke , Direct relation b/w Price & D/P ratio but inverse relation b/w price & retention ratio. c. R = ke , No relation.
Where, P = Price D = DPS R = Internal rate of return Ke = Required rate of return E = EPS Conditions: a. When r > ke , Inverse relation b/w Price & D/P ratio.
IV.
MM Approach:
If dividend paid:
a) Calculate expected price:
Q3. The dividend payout ratio of a firm is 40%. The firm follows traditional approach to dividend policy with a multiplier of 6. The P/E ratio of the firm is a) 4.4 b) 5.2 c) 6.7 d) 8.1 e) 9.5 Q4. Fast food posted a net income of Rs 15 million this year. Financial planners at fast food anticipate to have a capital budget of approximately Rs 18 million. The firm also anticipates retaining its target capital structure of 60% equityand 40% debt. If the firm follows a strict residual dividend policy, what is their expected dividend payout ratio? a) 28% b) 36% c) 50% d) 64% e) 72% Q5. The following information regarding the equity shares of M/s. Mars Ltd. Is given below: Market price = Rs 58.50 Dividend per share = Rs 5.00 Multiplier = 7 According to the traditional approach to the dividend policy, the EPS for M/s. Mars Ltd is: a) Rs 5 b) Rs 10 c) Rs 15 d) Rs 20 e) Rs 25 Q6.The market price of a share is Rs.150, the rate of return is12%, cost of equity capital is 11% and earnings per share is Rs.15. According to Gordons Capitalization model, the retention ratio of the firm is (a) 20% (b) 30% (c) 40% (d) 50% (e) 60%. Q7.The market price of a share is Rs.109.375, the capitalization rate is 12%, earnings per share is Rs.15 and the return on investment is 10%. As per Walters Model, the dividend per share is (a) Rs.2.75 (b) Rs.3.00 (c) Rs.3.57 (d) Rs.3.75 (e) Rs.3.95 Please visit for more info: www.financialpath.in
Q8.Consider the following data for Bits Telecommunications Ltd.: Earnings Per Share (EPS) Rs.10 Dividend Payout Ratio 50% Equity Capitalization Rate 10% Rate of Return on Investments 12% If the number of shares outstanding for the firm is 2,00,000, the market value of equity according to Walter model is (a) Rs. 1,10,00,000 (b) Rs. 2,20,00,000 (c) Rs. 3,30,00,000 (d) Rs. 4,40,00,000 (e) Rs. 5,50,00,000 Q9.The following information regarding the equity shares of Venus Pharmalabs Ltd. is given: Market price per share Rs.17.00 DPS Rs. 3.00 Multiplier 3.40 According to the traditional approach to the dividend policy, the EPS for Venus Pharmalabs Ltd. Is approximately (a) Rs. 2 (b) Rs. 4 (c) Rs. 6 (d) Rs. 8 (e) Rs.10 Q10. The current market price of Aditya Industries Ltd is Rs 75. The earning of the firm are Rs 5,00,000 and there are 50,000 shares outstanding. The companys cost of capital and the return on investment are 15% and 16% respectively. The dividend yield on the companys share using Gordons dividend policy is: a) 1% b) 2% c) 3% d) 4% e) 5% Q11. United industries Ltd. has recently paid a dividend of Rs 3.60 per share. The earning per share of the company for the current year is Rs. 14.40 and the cost of equity capital of the company is 18%. It is assumed that Walters model on the dividend policy is applicable to the company. The existing market price per share of the company is Rs 65. What would be the percentage change in the market price of the companys share if the earning per share increased to Rs 18 and the payout ratio is 40%? a) -3.76% b) -5.69% c) 4.67% d) 7.69% e) 9.56% Please visit for more info: www.financialpath.in
Q12. Mohit industries follows a stricy residual dividend policy. The company has a capital budget of Rs 80 lakh. It has a target capital structure, which consists of 40% debt and 60% equity. The company has 2 lakh shares outstanding. The company forecasts that its net income will be Rs 60 lakh. If the multiplier were 6, the market price of the companys share as per Graham-Dodd model (Traditional Model) would be a) Rs 80 b) Rs 96 c) Rs 106 d) Rs 112 e) Rs 136 Q13. A closely-held chemical manufacturing firm has been following a dividend policy which can maximize the market value of the firm. It is also perceived that Walters model to dividend policy holds good for this company. Accordingly, each year at dividend time, the capital budget is reviewed in conjunction with the earnings for the period and alternative investment opportunities for the shareholders. In the current year, the firm reports net earnings of Rs 5,00,000. It is estimated that the firm can earn Rs. 1,00,000, if the net earnings of the current year are retained. The investors have alternative investment opportunities that will yield 15%. The firm has 50,000 shares outstanding. The P/E multiple of the shares of the company is a) 8.1 b) 8.9 c) 9.6 d) 10.2 e) 11.6 Q14. A textile company belongs to a risk class for which the cost of equity is 10%. It currently has 50,000 shares outstanding selling at Rs 100 each. The firm expects earning of Rs 5,00,000 during the period and therefore it is contemplating to declare of Rs 8 at the end of the current year. The company also has a new project which requires an investment of Rs 10,00,000 during the same period. the value of the firm assuming that the MM model holds good is a) Rs 37 lakh b) Rs 45 lakh c) Rs 50 lakh d) Rs 56 lakh e) Rs 60 lakh Q15. Akruti Constructions Ltd., (ACL) is intending to acquire substantial shares in Jagruti Projects Ltd.,(JPL) to acquire control in the company. The beta factor of JPLs shares is 1.6 and the current market price of its each share is Rs 170. The company is consistently paying a dividend of Rs 46 per share every year and is expected to pay the same amount even in the future. The risk free rate is 6% and the market rate of return is 18%. How much extra amount should ACL pay for each share over the current market price so that the price of the share of JPL is at equilibrium as per the CAPM approach? a) Rs 12.54 b) Rs 16.24 Please visit for more info: www.financialpath.in
c) Rs 19.52 d) Rs 23.12 e) Rs 27.34 Q16. Bunny Projects Ltd. Is an all equity firm and reported net earnings of Rs 6,84,000 for the current year. It has a paid up capital of Rs 20,00,000 and the face value of each share is Rs 20. The company has a policy of retaining a part of its earnings and reinvesting them in various projects. If the company can earn 25% on such earnings, the cost of equity capital is 12.5% and the growth rate is 6%, the price of the share as per the Gordons model for dividend policy approximately is a) Rs 56 b) Rs 60 c) Rs 69 d) Rs 72 e) Rs 80 Q17. Jaya Hotels Ltd. has a book value per share of Rs 137.80. Its return on equity is 15% and it follows a policy of retaining 60% of its earnings. If the opportunity cost of capital is 18%, the price of the share computed as per the Walters model differs from that computed as per the dividend growth model by approximately a) Rs 6.97 b) Rs 7.89 c) Rs 3.19 d) Rs 11.46 e) Rs 12.10
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Or 70(0.16) = D + (0.14 / 0.16) (12 D) Or 11.2 = D + 0.875 (12) 0.875D Or 0.125 D = 0.70 Or D = 0.70 / 0.125 = Rs 5.60 Therefore, Dividend payout ratio should be = D/EPS = 5.60/12 = 0.47 or 47% . 2-Answer (c) The market price per share is given by where symbols are in standard use. If no dividends are declared P1 = Rs 168 Net income = Rs 2 crore Investment budget = Rs 4 crore Amount to be raised by issue of new shares = Rs 2 crore Therefore, number of shares to be issued = 3-Answer (a) According to the traditional approach ( Where symbols are in their personal use Substituting the values, we get ( ) ( ) Therefore, P/E = 4.4 )
4-Answer (a) Capital budget = Rs 18 million Debt - equity ratio = 40 : 60 Therefore debt = 18 (40 100) = Rs 7.2 million Rest capital budget = Rs 18 million Rs 7.2 million = Rs 10.8 million Net income = Rs 15 million Therefore residual dividend = Rs 15 10.8 = Rs 4.2 million Dividend payout ratio = Rs 4.2 million Rs 15 million = 28% 5-Answer (b) According to the traditional approach ( ( or, or, E/3 = 3.35 or, E = 10.05 = Rs 10 6-Answer (d) According to Gordons dividend capitalization model
( )
) )
b = 0.50 or 50% 7-Answer (d) According to Walters Model P= D+ ( E- D ) r / Ke Ke ( D = 3.750 8-Answer (b) According to walter model = =
( ( ) ( ) )
= 50 + 60 = 110 Therefore market value of equity = 110 2,00,000 = Rs 2,20,00,000 Please visit for more info: www.financialpath.in
9-Answer (c) The traditional approach to dividend policy establishes a relationship between the market price and the dividends in the following manner: P = m (D+E/3) where, m is a multiplier, D is the Dividend Per Share (DPS) and E is the Earnings Per Share (EPS). Hence, 17 = 3.4 (3 + E/3) So EPS = Rs.6 10-Answer (e) In order to find the dividend yield we need to first get the dividend payout ratio. E = current earnings / number of shares outstanding = Rs 5,00,000 / 50,000 = Rs 10 per share Ke = 0.15 r = 0.16 According to Gordons dividend model, P=
( )
75(0.15 b 0.16) = 10 (1 - b) 11.25 12b = 10 10b 12b 10b = 11.25 10 b = 1.25 2 b = 0.625 Therefore dividend payout ratio = (1 - .625) = 37.5% Dividend paid per share = 0.375 10 = Rs 3.75 Dividend yield = Dividend per share / Market price = 3.75 / 75 = 5% 11-Answer (d) According to walter model on dividend policy, P=
( )
Given, Market price of the share, P = Rs 65 Cost of equity capital, ke = 18% Earning per share, E = Rs 14.4 Dividend per share, D=Rs 3.6 Investors required rate of return, r = ? Substituting in the formulae: Please visit for more info: www.financialpath.in
65 = (20) + (60) (r 0.18) 60r / 0.18 = 45 r = 45 0.18 / 60 = 0.135 or 13.5% if the earning per share increased to Rs 18 & the payout ratio is 40%, it implies dividend paid is Rs 7.2. therefore, P=
( )
= 40 + 30 = Rs 70 Therefor the market price of the share would increase by Rs 5. In percentage term, it would increase by 7.69%. 12-Answer (b) Equity required to maintain capital budget: Capital Rs 80,00,000 Percent of budget financed with equity 0.60 Amount to be retained Rs 48,00,000 Dividend : Earnings Rs 60,00,000 Less: equity retained - 48,00,000 Dividend Rs 12,00,000 Therefore Dividend payout ratio = Dividend / Earnings =Rs.12,00,000/Rs 60,00,000 = 0.2000 = 20% Earnings per share = 60lakh / 2 lakh = Rs 30 Dividend per share = 0.2 30 = Rs 6 According to Graham-Dodd model(Traditional model),market price of the share is given by, P = m (D + E/3) = 6(6+30/3) = Rs 96 13-Answer (b) According to Walters model for dividend policy, {
( )( )
The optimal dividend payout ratio depends upon the return on investment and the cost of capital. Here r, = 1,00,000 / 5,00,000 = 0.2 or 20%. The cost of capital is given as 15%. The return on investment is greater than the cost of capital. In such a case, the value of the companys share is maximized when the dividend payout ratio is zero. Therefore, [
( )( )
E = EPS = Net earnings/Number of shares = 5,00,000/50,000 = Rs 10 Please visit for more info: www.financialpath.in
14-Answer (c) Price per share at the end of the year: Ke = 10% Po = 100
( )
=
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Shares
= Rs 50,00,000. 15-Answer (a) Cost of equity=Expected return on a security=ke = Rf + (Rm -Rf) = 6% +1.6 (18%-6%) = 25.2% = Dividend paid / Expected return = 46/0.252 = Rs 182.54 The share is said to be correctly priced at Rs 182.54. But the current market price is Rs 170. Therefore ACL can afford to spend Rs 12.54 (182.54 170) over the current market price on each share so that they get the correct price. 16-Answer (e) According to Gordon model for Dividend policy, P = Where, E = EPS b = retention ratio ke = cost of equity capital r = return on investment Net earnings Number of shares (Rs 20,00,000/20) EPS Given g = br 0.06 = b*0.25 = .06 .25 b = 0.24 Ke = 12.5%
( )
= Rs 79.98 or Rs 80
17-Answer (c) Book value per share Rs 137.80 Return on equity 15% Retention ratio 60% Dividend pay out 40% EPS = Book value * ROE 137.80*0.15 = Rs 20.67 DPS = EPS * 0.4 Rs 8.27 Opportunity cost of capital 18% Growth in dividend = br 0.60.15 =9% Calculation of share price using dividend growth model Po =
( )
=
)( )
= Rs 100.16
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)
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Therefore share price computed from Walter model is more by Rs 3.19 from that computed from the dividend discount model. 18-Answer (d) According to Walter model on dividend policy { {
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}
)
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DPS = Rs 5.60 Therefore, dividend payout ratio should be = DPS EPS = 5.60 12 = 0.47 or 47%
THEORY
1. Traditional approach by B Graham and DL Dodd: The stock value responds +ly to higher dividends and ly when there are low dividends. 2. Traditional approach states that P/E ratios are directly related to the dividend pay-out ratios. 3. Dividend policy by James E Walter also considers that dividends are relevant and they do affect the share price. According to him: Please visit for more info: www.financialpath.in
a. When the ROI is more than the cost of equity capital, the earnings can be retained by the firm since it has better and more profitable investment opportunities than the investors. b. When the ROI is less than the cost of equity capital, all the earnings should be paid to the investors. 4. Gordons Model assumes that the investors are rational and risk-averse. They prefer certain returns to uncertain returns and thus put a premium to the certain returns. Thus, investors would prefer current dividends and avoid risk. 5. Miller and Modigliani have propounded the MM hypothesis to explain the irrelevance of the firms dividend policy. According to this model, it is only firms investment policy that will have an impact on the share value of the firm and hence should be given more importance. 6. According to the rational expectations model, there would be no impact of the dividend declaration on the market price of the share as long as it is at the expected rate.