,According to _the a~ove example and Gordon's theory, when 'r' is greater than 'k/, price rises

retentions i.e.
•th more
wt When r> kt' price increases with increase in retention ratio. ~-.. w~--:·=~-~:-?."·,.,.,,..>·~.&1"~
!;th firnl).Optimum D /P ratio is zero. ~ The concl~lons Of~tn
(gtO When r < kt' more retention s leads to fall in the market Model are similar~ •·2l.,
2. f
i
rice- (Declining um)•OptiJn. u~u
D/P ti • 100 ¼
ra o is oo.
•becausethesemodels1P
~: llmllarassurnptionL- t(~,,
P _ When r = k, retention ratio do not affect the market price. r...:-~ ~~--~ ..:-.... :,-;n.t.£~,a..a•
3 4,,o.,.,. _;,-,~~~••

(Normal firm)
The conclusions of Walter and Gordon's model are same because both the models have been
ed on the basis of same assumpti ons.
develop

POINTS TO REMEMBER

l, Dividend is the portion of profit (after-tax) which is distributed among the shareholders of the lira_ J
~ • _ Alternative to the distribution of dividends is retained earnings. Dividend decision is an important'::}
r decision taken by the financial manager. • • ••_-.- -i
f • There are two theories named Residual theory and MM hypothesis, which ass~e dividend as · i
~ irrelevant to the valuation of the firm. • -. . • •- • _,
! • According to Residual Theory dividend decision is a residual decision and the amount to be distributed
! as dividend is a balancing figure calculated after deducting the amount to be invested from the profit. 1
J
t • MM Approach has argued that firm's dividend decision is irrelevant to the value of the b According .{
f to this approach, value of the firm is determined by the earnings of the firm and it's investment policy. )
'
t. • MM model is based on unrealistic assumptions hence an impracticable proposition. :. ••. . . •• .• ,- l
• ~·
~ • According to Walter's Model, value of the firm depends upon £rim's earning level, dividend
payout,•:~
l constant reinvestment rate and the shareholder's expected rate of return. ••.
-
· · - : • - _:
. . . -I

f • The optimum dividend policy as per Walter's Model is determin ed~ the basis of reinvestment rate --l
r . (r) and the shareholder's expected rate of return (kt). If r > k~ then the optimum di~dend policy is
f. 100% retention; If r < kt' then the optimum dividend policy is 100% payout ~d ~~ r = k, ~ :•.i1
L dividend policy is irrelevant for valuation of a firm. ., . , • . . ·· .·:;
~ • According to Gordon's Model, dividend policy ·of a firm is relevant and can affect the value of the-· ·i
; firm. Uke Walter's Model value of the firm under this model also depends upon reinvestment rate i
: (r) and shareholder's expectations (ke). • · • •· - •• ·_ • ••• •• •• •• · -~
t • Walter's and Gordon's models consider the dividend decision as a relevant decision to thevalue of the firm_.~
f ·i.t. investors prefer to receive dividend income being certain instead of receiving capital gain, in fu~ , •i
~ • The conclusions of the Gordon's Model are similar to Walter's Model because these ~ ue ti
:· based :~:1 · • • - ·_ · ·• · =. •• iS
:.: ;_ ~- 'h
,
ons.wwarassumptions.
, . ".. J..; • .
. . •. . . ._, •• _ ·_ ...: ,:. :.,.,.._._~~
...:, ,. ., .-.. c~...c-·-,.-,..
..-.t.A..:...•~•..,.,,. ••, ~ ~
,,, . . . - • ..............••., :\. ,.., . •·4••'-" •-•..... .,..#...,. .. ,~.,. . . . . . . .

~
LIST OF FORMULAE
•. • L lrreleva the •
j. C., Mt,t;,r o:~of dividend and valuation of the
firm
._ .. _ . . _· _ _. __ ;_
( -_ . (~ C~t ~ket price of the share (PJ = PV of expected dividend ~1) + ~:of
. ,
. . .
.. Di +f\
. •' pO= . 1+Ice ..· ...
·'

. . . . .
.,. .•.•• .2 .... ~•..: . • ~, • • . """"'-·. . .,,,.._. .;~- •S-..,•--1

•
 ~-M~nage··
-~,-..A.•• .. .. -

~ .• . •r• • " ... ":I .. , , - . _ .., , " . , . , .. •.• - • • .....; . . .• . - · , . •, . , ....... , , - • • · ,,.....,.

~:··,·:~ (ii)~Vai~; of the-~ ; ;.;;~~ ing ;,, numbe r of outstanding ~res

,. 11 •
1
: • • rD1 + rP1
'
..r . . •.
~ · · (m) Value of new shares to~ issued
. .
•

s P = I - (E - r 0 1) = I - E + r 0 1 •
rPo • 1 +k
l
~- . Where 5 is the number of new shares to be issued at expected price Pi (Ex-dividend price) ~ j
~ (iv) Number of new shares to be issued (s)
1
•• .
t s=
I - (E - rD1 )
]
!
t . ~ t
:: . (v) Value of the firm with additional investment: ' I

~
I . . 1
r t_~ • rP = - - x [(r+ s)P1 -I +E] l
"I
"t l o (1 +kt) J
1
! (vi) . Value of the firm with a~ditional investment using P1 = P1 x N (Where N =
r + s) -
1
.1
t ii. Relevance theory of dividen d and valuation of the firm
,\

\I ; "') Walter's Model

.t i

I
• • ( r) ( ] •
I .. D l1r,. {E- D) D+ li {E- D)
i . (1) Market price of equity share (P) = "9 + ke or
(u) Value of firm= N X p
where, N = No. of outstanding shares
(I,) Gordon's Model
• . . E{l-b) j
(i) Market price of the equity share (P) = k _ br
e
.
'
~
i (ii) Value of the firm = N x P .
.J

i . ·· where, N = ~o. of equity shares outstanding. .

J
l ....": . .,!- -..:.... ._ ..." ..... -·•·.-" ..... _._ • ~- .. .'" ~ ......... ~ •

• GRADED ILLUSTRATIONS/ EXAMINATION QUESTIONS

Illustration1. SR Ltd. has a cost of capital of 15%. Current market value of the firm is f 30,00,00
0 i.e. t 30
per share. Assume invesbnents required is f 7,00,000, earnings of the company are~ 2,50,000
and expected
dividend to be paid , 2 per share. Show that the payment of dividend doesn't affect
under MM model. the value of the finn
Solution: (A) Whm dividend is paid :
(i) Expeded Market Price of the Share when Divide nd off 6 is paid (MM
Model) :
p - 01 +P1
o- (1 + kt)
Where, PO = Current market price of the share
P1 = Expected market price of the share at the end of year one
0 1 = Expected dividend at the end of year one
k1 = Cost of equity capital
30 - 2+P1
- (1 + 0.15) => P1 = 30(1.15)- 2 = f 32.5
 t required for fina ncin g :
= 1- (E - rO1) where, I= total investment required
a,, Ainoun
E = Earning of the company
r = Num ber of shares outs tand ing
= 7,00,000 - (2,50,000 - 1,00,000 >< 2)
= 7,00,000 - 50,000 = f 6,50,000
.. urnber of new shar es to be issu ed (s)
,,,,, N __ 6,50 ,000
= 20,000 shares.
32.5
. ) A per MM mod el, valu e of the firm :
(,11 s
1
rpo = 1 + k [(r + s) P1 - I+ E]
e

Where, r
=Number of shar es outs tand ing
es issu ed
5 = Number of new shar
p1 =Expected pric e at the end of the year .,
.
pO = Curr ent pnce
l = Total inve stme nt requ ired
E = Earnings of the com pany
kt = Equity capi talis ation rate
(1,00,000 + 20,000) 32.5 - 7,00,000 + 2,50 ,000
- 1.15
39,0 0,00 0- 7,00,000 + 2,50,000 f 30,00,000
- 1.15 =
(B) When divid end isno t paid :
+ Pi ⇒ P1 = f 34.5
P - Di + Pi ⇒ 30 = O1.15
(i) Market price: o - 1+ ke

(ii) Amount requ ired for_ fina ncin g

=I- (E- rD1)
= f 4,50,000
= 7,00 ,000 - (2,50,000- 0)
,000 /34.5 = 13,043.5 shar es.
(iiil Number of shar es to be issu ed (s) = 4,50 •
(iv) Value of the firm whe n divi den d
is not paid
- l [(r + s)P1 - I+ E]
1 + ke.
45
( 1,00,000 + , o,ooo) 34.5 - 7,00,000
-
+ 2,50 ,000
·
_ 34.5
1 + 0.15
= 34,50,000 = '30,0 0,00 0
1.15
thet firm
The above calculations show that the valu e of the firm will rem ain the sam e at f 30,00,000 whe
Pays dividend or not. -
pet share is
lllustr'. t • equi ty shar es outstanding. Curr ent mark et price
f 150 a ion 2. . D company curr ently has 10 lakh . Cost of equi ty is 12%.
and inve sbne nt budg et is f 4 crore
The •The net ~com e for the curr ent year is f 2 crore f 8 per share. Assu ming M-M appr oach :
company IS contemplating declaration of divid end @
ct~ is decl_ared and if it is not decl ared .
~alculate the mar ket pric e per shar e if divi dend er both opti ons?
ow man y new equi ty shar es are to be issu ed
und
(iii)
Show that the total mar ket valu e of shar es rem
ains unaf fecte d by the divi dend decision.
(B.Com(H) Delh i Univ . 2006, 2009]
 Solution: Whtn Di'uidend is Paid:
D1 +~1 8+P1
(I') Current market price per share (P0) = => 150 = l.1 2 ⇒ 150(1.12) = 8 + p1
1+k,
Expected market price per share (P1) = 168 - 8 = 160
(ii) Amount required to be raised : = 1 - [E - rD11
= 400,00,000 - [200,00,000 - 10,00,000 x BJ
= 400,00,000 - 1,20,00,000 = t' 2,80,00,000
2 80 1,75,000 shares.
t
I
Number of new shares to be issue d:= ' ;:,oo o =
I + 1,75,000 = 11,75,000 shares
·I'
(iiiJ Total number of shatts after new issue:= 10,00,000
(ii,) Total value of the firm: = 11,75,000 x 160 = t' 18,80,00,000
•
When Di'oidnul is not Paid:
= O+~ ⇒ 1~= (1 +~0.12) ⇒ p t = 1~(1.12) =f 168
(i) Market price per share (Po> : 1 + kt
= 1-[E -rO1] = 400,00,000- (200,00,000-Nil
]= 2,00,00~
(ii) Amount required to be raised : 1,19,047.62 share s
00,000/168 =
Number of new shares to be issued : = 2,00,
,000 + 1,19,047.62 = 11,19,047.62 shares
(ii,1 Total number of shares after new issue : = 10,00
(ii,) Total value of the firm = 11,19,047.62 X 168 = f 18,80,00,000
of the firm will remain the same at t' 18,80,00,000
Conclusion: The above calculations show that the value
whether firm pays dividend or not.
Illustration 3. Data:
t' 10
EPS 10
P/E ratio
10%
~ 20,000
No. of outstanding shares f5
Expected Dividend f 2,00,000
Expected Net Income f 4,00,000
New Invesbnent
affect the value of the firm. Use the above data
As per MM approach, the payment of dividend does not [B.Com(H) Delhi f:1nivmity2011J
to prove the statement.
tions:
Solution: MM hypothesis can be proved unde r two situa
Situation I: When Dividend is Paid :

(a) Market Price: p = 0 1 + Pi ⇒ 100 = 5 + P1

0
1+k, l+0.1 0

. pt = 100(1.10) - 5 ⇒ P1 = f 105
Therefore, Po= EPS x p /E = 10 x 10 = 100) •
(Here, Po JS calculated by multiplying EPS and p /E.
(b) Amount to be raised through issue of new
equit y shares.
= 1-[E -rDi J
= t' 4,oo,000 - [2,00,000 - (20,000 x S)J
= 4,00,000 - [2,00,000 - 1,00,000]
• = 4,00,000 - 1,00,000 = t' 3 00 000
(c) Number of new shares to be issue = 3,00,000/l0S 2 7
d = ,85 sha~es~
 ,,,v,lue of the Firm: rP -
o - l +l k x [(r + s)P1 - I + E]
t

rPo = 1 x [20 000 3,00,000]

1 + 0.10 ' + 105 105-4,00,000 + 2,00,000
'
1
= 1.10 X (24,00,000- 2,00,000) =' 20,00,()()()
Situ4 tion U: When Divid end is not Paid

(a) Market Price: po = D1 + P1 ⇒ 100 = 0 + P1

1 + kt 1.l0 ⇒ P1 = 100(1.10) =' 110
(b) Amount to be raise d throu gh issue of new equit
y shares.
= l-[E -rD1]
= 4,00,000 - (2,00,000 - Nil] =, 2,00,000
(c) Number of new share s : 2,00,000
- = 1,818 shares.
110

(d) Value of the Firm: 2

rPO = 1.~ [ ( 20, ooo + ·~;goo)110 - 4, 00,000 + 2,00,000]
0
1
= l.l0 X [22,00,Q00-2,00,00Q) =' 20,00,()()()
Conclusion: According to MM hypothesis, value of the firm will
remain same irrespective of the fact whether
company pays divid end or not.
Nott: Value of the firm at the end of the year can also
be find out unde r both the above situations using P •
1
Sihuation I: Whe n divid end is paid .
Value of the firm = P x N Whe re, N is No. of outst andin
1 g shares including the new equity.
P1 is the price at the end of the year.
= 105 x 22,857 =, 23,99,985 or, 24,00,000 (Approx)
Situation II: Whe n divid end is not paid.
Value of the firm= p x N = 110 x 21,818 =, 23,99,980 or,
1 24,00,000 (Approx)
Illustration 4. Relay International belongs to the risk class
for which the a?prop~_te capitali:,ation rate is 10%.
It currently has 1 00 000 equit y shares of, 80 each. It is think
ing of declaring a dividend of' 4 ~ share at thetof
end of the y'?ar. It' is'expecting a net income oft 8 lakh and an •
' 15 lakh. Show that unde r MM assum tions, payment of divid mvestment proposal reqwn•n·g an mvesfirm tmen
end does not _~ e th
and after th ·
e lSSue of new sh ares. p [B Com(H) Delhi Univ.2019; Similar questi~al~
on in
of tbe
2008,2
now
013,2015)
• ' .
Solution: (i) C,dcu latio n of price of the share:
Situation I: When Divid end is paid:
D1 +Pt ,so= 4 +P1 ⇒ P1='80 (1.10 )-4= > P1 ='84
Po= 1 + ke => 1 + 0.10
Situation II: When Divid end is not paid:
_ D1 +P1 ⇒ ,80= O+P1 ⇒ P =t88 (1.10 )-0 => P1 • '
Po- l+k, 1 •
1+0.10
 (ii) Calculation of Value of the firm:
I (E D J
Situation I: When Dividend is paid: shares : - - r 1
Calculation of amount to be raised throug h issue of new equity
⇒ f 15,00 ,000-( 8,00,0 00-(l, 00,00 0 x 4)] =f 11,00,000
.
Numb er of new shares to be issue= l 1,00,000/f84 = 13,095.238 shares
I
f 1 -I+ EJ
Value of the Firm: rP = x [(r + s)P1
o 1 +kt

rPo= _!_[(l, 00, (XX)+ 13,095.238)84-15,00, 000 + 8, 00, 000]

1.10
: _!_ X (88,00,000) =f 80,00,000
1.10 .

Situation II: When Di'oidend is not paid:

shares :
Calculation of amou nt to be raised throug h issue of new equity
I- {E - rD1J⇒ f 15,00,000 - [8,00,000 - (1,00,000 x 0)J =f 7,00,00
0

Numb er of new shares to be issue = 7,00,000/f88 = 7,954.545 shares.

I
f 1 00, cm+ 7,954.545)x88-15,00,CXXJ+8,00,CXX>]
'j
Value o~tht Firm: rPO= 1+ 0.10 xr(l
.I 'I LI ,

~ =-
1 X (88,00,000) = f 80,00,000
I
I 1.10
be unaffected irrespective of the fact
Conclusion: According to MM hypothesis, value of the firm will
wheth er company pays dividend or not.
(iii) Calculation of Value of the firm at the end of the
year under both the above situat ions using Pr

Situation I: When divide nd is paid: Value of the firm =P1 x N

P is the price at the end of the year:
Where, N is No. of outsta nding shares includ ing the new equity and 1
!
,.I
Value of the firm = f84 x 1,13,095.238 = f 95,00,000
.' Situation II: When dividend is not paid:
( Value of the firm = P1 x N ⇒ f88 xl,07,954.545 = f 95,00,000
capital consis ting of share off 10 each.
f Illustration 5. Ram Maya Ltd. curently has flOO lacs equity share
curren t year is f 2 crores and investment
Curre nt market price per share is fl5. The net income for the
contem platin g the declar ation of dividend
i. budget is also off 2 crores. Cost of equity is 12%. The compa ny is
@f 1 per share. Assuming Modigliani and Miller Appro ach:
i
I if it is not declared.
(,) Calculate market price of the share if dividend is declared and •
I (i1) How many new equity shares are to be issued under both
options?
divide nd decision.
(iii) Show that the total value of shares remain unaffected by the
l B.Com (H) Dtlhi Uniu. 2015]
Solution: (i) Situation I: When Di1Jidend is declared:
P. = D1 + P1 ::) 15 - 1 + P1
o 1+k~ - 1 + 0.12 ⇒ P1=15(1.12)-1 ⇒ P1 =f15.8O

Situation 11: Wha Diflitletul la not declared:

 0 + nc1 0
p =
D 1+ ~1
---- ⇒ 15 =
+ 0.12 => P1 = 15 (1 .12)-0 => pl = f 16.8
1 + k, 1
0
to be is su ed w he n dividend fa paid:
ne w •~ares Is paid•
s; ,- ti ol l I: N ~ b er of of ne w eq ui ty sh ares when dividend
(Ill ~O U Jl l to 1,e raue
d through issue = I - [E - rD ]
•
1
]
,000 - (10,00,000 )C 1)
='- 2,
2,00
00 ,0
,0
0,
0,
00
00
0
0
-
-
1,
(2
90
.0 0,00
,00,000 = ' 10,00,00
0
shares.
.
su ed = f 1? ,0 0, 00 0/ f 15.80 = 63,291 _14 ~
NUJllber of new sh
ares to be is he n di vi de nd is no t paid: .
ha re s to be is su ed w pa id :
:,

of ne w s_ nd is no t
Si,_.tion II: N ~ b e r su e of ne w eq ui ty sh ar es
w he n divide
th ro ug h is
AJnount to be raised . = I - [E - rD1J 00 x 0))
.00,00,000 - (10,00,0
= f 2,00,00,000 - (2 0 = f Nil • ·
,0 0,00 0 - 2, 00 ,0 0,00
= 2,00
N il
es to be is su ed =
Number of ne w sh ar
1
k, x [(r + s)P1 - I +
E]
,lw of th e Firm: ro = +
(iii) V 1
( as su m in g fa ce va lue o f the share f 10):
idend is Paid •
Sihlllff.on I: When Div ',
V,lue of the Firm: o,000)
1 4) x 15 .8 0- 2, 00 ,0 0, 00 0 + 2,~,o_. .. ,
.1
= + _ x [( to ,0 0, 00 0 + 63,291
rP0 1 0 12
1 0,()(),()()()
= - X (1,68,00,()()(}) = f 1,5
1.12 e f 10):
ming face value o f the shar
n U: When D iv id end is no t Paid( assu .
Situtio I •
.,
1 0) 16 .8 0- 2, 00 ,0 0, <XX>+2,00,00,(D)] _
>+
: rP0 = -[(t0,00,CXX .
V,lue of th e Firm 1. 12
•
0
)()()) = f 1,50,()(),00
- J X (1,68,00,,( ,
1.12 . fact~
fi rm w ill re m ain sa me irrespective of the ., / . . .
hy po th es is , va lu e of th e ed as flO . .
Coiicl11Sion: According
to M M be en assum .,
or no t. Fa ce va lu e of each sh ar e ha s t un de r bo th th e above aitaa6am .
nd be fi nd ou
:a'pany pays divide th e en d of th e ye ar ca n al so •
e fi rm at
P. Off: Value of th
1J.e. .
e o f th e shtire 'JO): .
s·ifiuitio. n I: When di vi de nd is pa id ( assum is No. of outstanding shares including the new eqully.
in g foee va lu
xN Where, N en d of th e year.
Value of the firm = p 1 p 1 is th e price at the I

0
291.14 = ' 1,68,()(),00
• = f15.80 X 10,63, •
.. ,, .g fa «" " " " o f tl, e ,lu lf f ,f l) : .
is no t paid( ..
~ II: When dividend N = ,1 6. 80 x. 10,00,000 = fl,
68,00,000
Value of the firm 1 = p x
k cl as s fo r w hi ch th e ~ I I P (t
belongs to ris
~ 6. A 1exti1e co m pa ny
eN ll in g at '1 00 ea da . 11ie fi rm ia c o
4~
.•~-
-O ll ll b m d in g lh an n en t ft lc al ye ar w b k h h u ju at st al 'll
,t ar z at . .w l o1 m
91111M '119'£
 (1) What will be the price of the share at the end of the year (a) if dividend is not declared (b) if diVid
'd~~? ~
(ii) Assuming that the company pays the dividend, has a net income of ,_s,oo,ooo and makes new invesbh-.
of' 10,00,000 during the period, how many new shares must be i~sued ~ -oqqa
(iii) What will be the value of the ftrm (i) if dividend is declared (ii) if dividend 15 not declared.
[B.Com (H) Delhi Univ. 6)
201

1 = _!_ = 0.10 =10%

Solution: We know k, = I 10
P E ratio
(i) Situation I: When Dividend is not declared:
p ·_ D1 + P1 ⇒ lOO = O+ P1 ⇒ p 1 = 100(1.10)-0 ⇒ P1 =f 110
I o- 1 + kt 1 + 0.10
I
II Situation II: When Dividend is declared:
l
11
p _ D1 + P1 ⇒ 100 = 8 + Pi ⇒ P1= 100(1.10) - 8 ⇒ P1 =, 102
o- 1 + kt 1 + 0.10
I'

~
,l
(ii) Amount to be raised through issue of new equity shares when dividend is paid.
= I - [E - rD1] ⇒ , 10,00,000 - [5,00,000 - (50,000 x 8)]
,
I . = 10,00,000 - 1,00,000 = ' 9,00,000
Number of new shares to be issued= 9,00,000/102 = 8,823.529 shares.
,,'
1
(iii) Value of the Firm: rP0 = - - x [(r + s)P1 - I+ E]
1+kt
Sihultion I: When Dividend is Paid:
1
Value of the Finn: rP0 = --x[(SO,CXXJ+8,823.529)xl02-10,00,CXX)+5,00,(XX)]
1 +0.10
, = _l_ X (55,00,000) =f 50,00,000
1.10
Situation ll: When Dividend is not Paid: Amount to be raised through issue of new equity shares
=I- [E- rD1]
= f 10,00,000 - [5,00,000 - (50,000 x O)]
= 10,00,000 - 5,00,000 = f 5,00,000
Number of new shares to be issued = 5,00,000/110 = 4,545.4 shares.

Valuuf tM Finn: rPO = 1.!oC(SO, 000 + 4,545.45) 110 -10, 00, 000 + 5, 00,000]
1
= 1.10 X (55,00,000) =f 50,00,000 _
Conclusion: According to MM hypothesis, value of the firm will unaffi t d • • f th fact whether
company pays dividend or not. ec e irrespective o e
Nou: Value of the firm_ at the end of the year can also be find out under both the above situations using P1·
Situation I: When dividend is paid.

. of the
Value . firm=. P1 x N Where, N is No• o f outstand.1ng shares including
. the new equity.
P1 IS the price at the end of the year. •

Value of the firm= 102 x 58,823.529 = f 60,00,000

 W)len dividend is not paid.
~ II: Value of the firm = P1 x N ⇒ 110 x 54545.45 = , 60,00,000

td belongs to a risk class for which the appropriate capitalizatiC>n Is 10 pl!rcent, It aam..dy
lioll ~- XL ()()() shares selling at , 100 ~ach. The firm is contemplating the declaration of a dividend of

~
~istandinS:• end of the current finanaal year. It expects to have a net income of, 2.50,ooo and has a
t~
11"pet' stiare at new investment of , 5,00,000. Show that under the MM assumptions, the payment of
for Dia ~feet the value of the firm?
~ -does not a [ B.Com(H), Delhi Univ.2018; Similar question in BBS, 2012)
A) When dividend is paid :
50/r,tiOII: (
(i) Expeded Market Prke of the Share when Dividend of, 5 is paid (MM Model):

p - D1 +P1
o - (1 + ke)

5+P1
100 = (1 + 0.10) ⇒ P1 = 100(1.10)-5 = t 105
•
(u1Amoun t required for financing would be
= I-(E-rD1)
= 5,00,000- (2,50,000-25,000 X 5)
= 5,00,000 - 1,25,000 = t 3,75,000
(iil1 Number of new shares to be issued (s)
3 75
,ooo = 3,571.429 shares.
= ,
105
(iv) As per MM model, value of the firm would be:
1
rp = - - [(r + s) P1 -I+ E]
o l+ke
(25,000 + 3571.429) 105- 5,00,000 + 2,50,000
1.10
30,00,000- 2,50,000 =, 25,00,~0
- 1.10
<B) When Dividend is not Paid :

h) Market Price: 01 +P1 ⇒ 100= 0/1~1 ⇒ P1=Ul0

Po= 1+ke
(ii)Amount required for financing = I-(E-rD1)
= 5,00,000- (2,50,000-0) =' 2,50,000

Wal Number of new shares to be issued (s) = 2,50,000

110 = 2' 272.727 shares.

(it>)Value of the firm would be : 'ZJ,50,000 •, ~»~....

50
_ (25,000 + 2,272.727) 110- s,oo,ooo + , '
2 000 => 1.10

&&a1ce, the value

1.J_
- uo
• the same at ' 25,00,000 w
of the firm will remain
hether firm paJ9 clhideNl.ar aat.
 Illustr ation 8. Expanding corporation is providing 25% retumS to ~ts shareh
old~. ~e current
of the shares is , 80 with 1.25 crore shares outsta nding . The firm 1s expe ct~
has been disbibu~
'4 aores in the year, while the investment requirement of the peri~ ~18" cro~es. It
6
dividend at 75% of its earnings. In view of its expansion requim1:'~t, it explo ~g
by
th
1SSu~
e preposition of
of fresh shares.
.:a~
enf!S
the dividend altogether for the year while mobilizing the rema ~g fun~s th
1 of pa~g _75% ~
the val~e of the firm (as per the MM Model) when the firm (a) contin u~ ~ th e.~li~
(b) deade d to skip the divide nd for the year. [B.Com(H), Delhi Umv.2 0ll, Smiilar question m 201~

4,00,00,000 - • 3 20 DPS(75%) = f 3.20 x75% = f 2.40

Solution: EPS -- 1,25,0 0,000 - ' • ' r, .....,

(A) When dividen d is paid:

(t1 Expected Market Price of the Share when Divide nd of f2.40 is paid (MM Model ) (Pl):
D +R 2.40 +P1
p = t t ⇒ 80=· - - - ⇒ P 1 =80(1. 10)-f2 .40=f9 7.6()
o (1 + kt') (1 + 0.25)

(ii) Amou nt required for financ ing would be: I -(E - rD1)
= 6,00,00,000- (4,00,00,000 -1,25,00,000 X f2.40) = f 5,()(),0(),(Q}
(iii) Numb er of new shares to be issued (s)
_ 5,00,00,000 _ 5 h
- - - - - - , 12,295 s ares.
97.60
(iv) As per MM model, value of the firm at the end of the year would be:
..
When divide nd is paid: P1 x N = f 97.60 x 1,30,12,295 = f 1,27,00,00,000
(Where N is no. of outstanding shares including the new equity)
(B) When dividend is not paid:

(t1 Market Price of the share (P1,:P = Di + Pi ⇒ 80 = O+ Pi ⇒ p 1 = f 100

o 1 + kt 1.25
(ii) Amoun t required for financing: 6,00,00,000- (4,00,00,000- l,25,00
,000 x f0) = f 2,00,00,000

!iii) Numb er of new shares to be issued (s) =OO' OO' OOO = 2 00 000 shares
21

100 I I

(iv) Value of the firm at the end of the year would be:

When divide nd is not paid: P1 x N = f 100 x 1,27,00,000 =f 1,27,00,00,000

(Where N is no. of outstanding shares including the new equity)
Hence, the value of the firm will remain the same at f 1,27,00,00,000 wheth er firm
pays dividend or not
Illustration 9. The following data relates to a firm in the cotton textile industry:
Number of equity shares outstanding 1,00,000
Earning of the company f 5 00 000
Dividend paid , ,
f 4,00,000
Rate of return on invesbnant 12%
Price- Earning ratio
. . lO hat
H the Walter's Model is used, are you satisfied with the current divide nt policy of the compa ny? Hnot, w .,
should be the optimal payout ratio? • ( B.Com(H) Delhi Unio. 2015i
.
 •

<J ') /
,.
5,00,0 00
-. • . (•) Workings: EPS = 1 ,00 ,000 =,s,
s,,-tlo#· ..
DPS= 4,00,0 00 =,
1,00,0 00 4
. E . (P/E) Rati' _ Market Price Per Share
Pnce- ammg O - , ⇒ 10
Earning Per Share
. f the share= P/E Ratio x EPS. ⇒ 10 x S =, SO
~•arket pnce o . ed th
of 100oYo d1v1de
JWJ • ket price 1s bas on e assumption • • •
nd payout ratio)
(11tlS ma~on of market price of the share at given divide nd payout:
ea1culati equity capitalization rate (kt) is the inverse of P /E ratio i e
We kf\OW, •• ,
1 1
k = --- - -
e P /E ratio - 10 --010 • = 10°'' 0
Dividend payou t ratio = 4 x 100 = 80%
5
Market price of the share as per Walter's model at 80% payout ratio:

4 + ( 0.12\ (5 - 4)
p = • o.1o) = , 52 ~
0.10 1 : . :: • • ,, _ .
Since r > kt' therefore as per Walter's Model optimum payout ratio should
be zero percent. We are not
satisfied with the firm's policy of 80% payout. Firm's value will be maximum
at zero percent payout (100%
retention). The market price of the share at optimum payout ratio i.e., when
D/P = 0 ~ ' •i
·o +(0.12 , cs-o). ....... • ..•
p = 0.10) =' 60
, ~ 1
· 010 •
..'· . •,
-: ·, .. : ' •

Therefore, the price can b~ raised from f 50 (at 100~/o payout ratio) to, 60(at
0% payout ratio). •
.. ·~ . i . . . ·' , . ~.;" • - ..
Illllstration 10. Following are ~e details regarding three ·compa nies: •

Internal rate of return (r) 15% 10% ,, 8% :·

Cost of Canital (k) 10% _., 10% • ' ' • •
.... i 10%
Earning per share \, 10 ·t 10 ., •• .,
, 10 ;• - ' :· -· .. ~
C
.
Using Walter's Model, calculate the effect of dividend P~~~t on the value
• I , • • • •

~f sl\ue ~f ~ of abQtt
COlllpanies, under the following situations: '
•. ' '

<? When no dividend is paid.

(~~ When dividend is paid at , 8 per share.
(iu) Whendivi'dend 1S • paid
• at, 10 per share. .
Explain the difference in the value of o( these companies as per Walter"a Mod~~-Coll (H}
•
OdW U... r
Solution: Calculation of current market price of the share ~8 per ~altQ?'a M~el
:•

D
.!.. (E-D ) o+(f)
(B-0 )
P = - + ~k,: . L - - ~ or __.;....; .•----
k, k, k,
 Value of Equity Share as per Walter's Model

. . ·· -·.:.. B'Ud . .•
•~ '
•. ..•· '·.
., .
•'C'Ud.... .
~· ,~-~{Nolm ld~) •~ .r < 1c. (OecDning firm)
' ' . . .
r = 15% r = 10% , = 8%
= 10% k• = 10%
k
• = 15% k
•E = , 10 E =, 10
E =, 10
. . . ..

0 08
o+(o.1o)c1 0-o)
0%, p =
0 +(0.15) (10 - 0)
0.10 p = 0.10 p = o+( 0.10
• )c10-o)

0.10 0.10 0.10

o=,o P =,
150 P = , 100 P =, 80

0 15 0 08
a+(o.1o)c1 0-2)
p = a+( • )c10-s)
0.10 p = 0.10 p = 8 + ( 0.10
• ) (10 -8)
0.10 0.10 0.10
o=,a P =, 110 P =, 100 P =, 96

= 10 +( 0.10
0 15 0 10 0 08
10 +( • ) (10 -10) • ) (10 -10) 10 + ( • ) (10 -10)
100%, p= 0.10 p p = 0.10
0.10 0.10 0.10
=
D ,10 P = , 100 P =, 100 P =, 100

Effects of Divided Policy:

(i) 'A' Ltd. is a u growth company'', Where r > kt. Therefore, to maximise the market price, the co~pany
needs to retain all its earnings, hence the price of the share is maximum with zero payout ratio.The
price decreases with increase in payout ratio.
(ii) ' B' Ltd. is a normal fim\ where r = k. In this case DIP ratio does not have any impact on the value of the
firm and it's share price. In nutsell, price of the share is unaffected by the dividend decision.
(iii) ' C' Ltd. is a "declining company'', Where, the rate of return is less than the cost of capital i.e.,
r < k~ To maximise the market price of the share, the company should distribute all its earnings as
dividend. Hence,the price of the share is maximum with 100% payout ratio. The price increases with
the inaease in payout ratio.
nlllSfrlJtim, ll. The following are the details regarding three companies :

BJ.tel. :.·.• · .:_· C Ltd,

r•15% r=5%
r=10%
K.= 10% K.= 10%
K =10
EPS•,a EPS=ta EPS=ta
•
Calculate ~-value of an equity share of each of these companies applying Walter' model when dividend
payout ratto 11 : . . 8

(i) 25% fli) 50% (iii) 7S% [B.Com(H) Delhi Unif1. 20lS]
 Walt or's Mod el;
Calculation of curre nt mark et price of the shar e as per
D (;)( E-D ) D+( _!__ )(E- D)
P= -+ t or ke _ __
--......;....k
kt kt
e
Valu e of Equi ty Shar e as per Walt er's Mode l

r = 15% r = 5% r = 10%
k• = 10% k.= 1001
,o k• = 10%
E=8 E=8 E=8

DIPRatlo _ -_. - _. _ .... , Market Price ofthe Shin <Pr ··: ·. ·:·. -· ;· ··.: :.
~ ~
.-:
·- ':· • -· ... - ,
• ~
~
. • •

2+(0 .15) (8-2) 2+(0 .05) (8-2) 2+(0 .10) (8-2)

P= 0.10 P= 0.10 P= 0.10
25%, 0.10 0.10
0.10

P =, 50 ,80
o=,2 P = f 110

4+(0 .05) (8-4) 4+(0 .10) (8-4)

4+ (0.15 ) (8- 4) 0.10
0.10 P= 0.10 P=
50%, P= 0.10
0.10 0.10
P = f 60 P=, 80
D=, 4 P =, 100

6+(0 .05) (8-6) e+(o .10) (8-6)

6+ (0.15 ) (8-6) P= 0.10
75%, P= 0.10 P= 0.10
0.10 0.10
0.10
P = f 70 P=, 80
D=, 6 P = f 90

payo ut ratio will bring down.the price of the

shareW~ha~e seen that in case of A Ltd. wher e, r > k., increasing also raises the market price of share.lastly in
payo ut ratio
case ~f Ccase of B Ltd. where r < kt' increasing the high
shares. Ltd. where r = kt' paym ent of lowe r or er divid end does not impact the mark et price of the
. .
lllustratio11 l2. The following information is collected from the current year annual report of JKL Ltd:
f 18,00,000
Earnings of the firm
3,00,000
Number of equity shares
22.5%
Rate of return on investment • •
15o/o
\Viia Cost of equity
~be tl_ie divi d~d payo ut ratio so asandto the keep the sruu:e price at '42 b y ~ Waltei:'•.Model? Also
et pnce of shares at the optimum d i ~ r,ou t)
ratio. What W:tt mur n dividend payo ut ratio sharemark price. . [B.Com(H), Dtlhi Unirl.2028
be the maximum and mini mum
S01.,ti011
Workings: Ea . _ Earning of the Company _ 18,0 0,00 0 =, 6
:
e (EPS) - N o.of Shares - 3 ,00,000
Gil . nung Per Shar
15%
en, Rate of return on investment (r) = 22.So/o; Cost of equity{kJ=
 Calculation of dividend per share (DPS) When share pric as per Walter's Model is t'42:

( !_J(E-D) (~)(6-D)
D ~ D ~~=15;__.--
p = - + - - - - ⇒ 42 = - +
0.15
015
•
k, k,

42 = D+ 9 -I.SD ⇒ 42 x 0.15-9 = -0.5 D

0.15
D =fS.40

. DPS 5.40 OO nn,o/

Dividend payout ratio = EPS x 100 = 6 x 1 = :,u to

The a,mpany's dividend payout ratio is not optimal. As per Walter's Model, wh~ r > k,, the price of the share
is maximum when DIP ratio is 7.ero. Hence, optimum payout ratio for the firm JS z.ero.
Calculation of Market price ( Maximum) of the share when D/P ratio is 0:

( 0.225) (6-0)
p = ~ + 0.15 ⇒ f 60
0.15 0.15

The price of~ &nare is mimimum when D/P ratio is100%.. Hence

( 0.225) (6-6)
p = __!_ + 0.15 ⇒ t' 40
0.15 0.15
Dl•smation 13. 1he following information for the current year about XYZ Ltd. is available to you :
F.amings of the Firm , 18,00,000
No. of Equity Shares , 3,00,000
Amount of dividend paid ,9,00,000
Return on Invesbnent 22.5%
Cost of Equity 15%

(i) • Calculate the present price of the share and value of the firm using Walter's Model
(ii) Is this the optimum payout ratio? Hnot, what is the optimum payout ratio ? What is the value of the
firm at this payout ratio ?
(iii) What is the payout ratio at which value of the firm will be lowest ?
(h,) What should be the payout ratio if the firm wants to keep its share price at , 55 ?
(r,) When will the firm be indifferent about payment of dividend 7
(B.Com(H), Delhi Unir,.2019; Similar question in 2010)
18,00,000 9 00 000
Sol11titnl: (I) Working,: EPS= 3,00,000 =f 6, ' '
DPS= 3,00,000 - 3
_,

Po• o+(f)CE-D ) ~P = 3+(~~)<6- 3) - ,

- 50
O
ke 0.15
 of the firm: = Po >< N ⇒ ' SO >< 3,00,000 =t 15,00,000
1atue k therefore as per Walter's Model optimum payout ratio should be
n.."\ SiflC! > fun\111\ payout ratio . The market price and value of the at in
,.., J\()t the op
r

payout ratio will be:

f i r m z e r o ~ p e r c e n t H e n c e , t h i s

O
0 225
0 + ( • ) (6-0) ,.
P= 0.15 ='60
0.15
Value of the firm: = Po >< N ⇒ , 60 >< 3,00,000 =, 18,00,000
(i) Value of the firm will be lowest at 100 % dividend payout ratio:

PY
~a
out ratio if the firm wants to keep its share price at ,ss·•
D+(0.225) (6-D)
O.l 5
'55 = ⇒ D =, 1.50
0.15
Dividend payout ratio= , 1.50/, 6 ⇒ 0.25 = 25%
(o) The firm will be indifferent about payment of dividend when , = k,.
Dl"6fflltion 14. The following information is supplied to you, about LK Ltd.:
F.amings of the company , 15,00,000
Dividend paid , S,00,000
Number of issued shares 1,00,000
Price- Earning ratio 10
Rate of return on investmant (%) 15%
(i) Determine the theoretical market price of the share as per Walter's Model.
(ii) Are you satisfied with the current dividend policy of the firm ? If not, what should be the optimal
dividend payout ratio in this case ? Fnd out the price of the share at that dividend payout ratio.
(B.Com(H) Delhi Univ. 2016, similar questions asked in 2008, 20111
- 15,00,000 5 00 000
Solution : Workings: EPS = l,OO,OOO =, 15, DPS = 1,00,000
' ' =,- 5
Market Price Per Share •
Price earning ratio (P /E) ratio = Earning Per Share => 10
Market price of the share =· P /E ratio >< EPS ⇒ 10 >< 15 =' 150
ffhis tnarket price is based on the assumption of 100°/o dividend payout ratio)
Calculation of market price of the share at given dividend payout:
We know, equity capitalization rate (k,) is the inverse of P /E ratio i.e.,
1
k - = _!_ =0.10=10%
t - p / E ratio 10
1
Dividend payout ratio = ~ >< 100 =33 3 o/o
15
ltfarL-.... "
at 33 l t tio.•
3 ~, payou ra
0/
sct Pnce of the share as per Walter's model 0

s+(o.1s, (15-5)
p = O.toJ .,200
0.10
 e~
um payo ut ratio shou ld be zero percent, henc
Since r > k,, therefore as per Walter's Model optim eareiq
nt
ut. Firm's value will be max imum at zero Perce
satisfied with the firm's policy of 33 .!. % payo . . PayOlat
3 DIP = 0
e at optimum payo ut ratio t.e., whe n
(l00% re\ention). The market price of the shar
0 5
O+ ( .1 ) (15- 0)
p = 0.10 = f 225
. 0.10
ut ratio)
150 100% payo ut ratio) to f 225 (at 0% payo
(at
Therefore, the shar e price can be raised from f
ago with an equi ty capital off 20,00,000. The
Other
Illustration 15. Ashley International started a year
relevant details are given below:
--Num-- --0 -- -
-- -- -- -- --20,00
ber of shares
Earnings of the company t 2,00,000
Dividend paid f 1,50,000
12.5
Price-earnings ratio
? What is the mark et pric e of the share at this
pay
(1) What is dividend payout ratio of the company el? out
rding to Walter's mod
ratio? Is the dividend payo ut ratio optimal acco
ratiowill have no effect on the value of the share
?
(it) What is the P/E ratio at which divident payo ut
is 8 ? (B.Com. (H) Delhi Univ. 2017)
(ii,) What will be your decision if the P/E ratio
Solution: Workings:
Earn
(EPS) =- ing of the Company 2,00,000
n gi..--
• gcer mue -= --- -= --- =- = - - - =flO
Eamm 20,000
No. of Shares

!
I
DiVJ.dend cer
O
re
Total ---
Sha (DPS) = --- -=paid
Dividend
No. of Shares
1,50,000
-- = - - - = f 7 50
20,000 •

= 2,00,000
Rate of return (r) = Earning of the Company X 100 = 10%
Total Capital 20,00,000

k = 1 1
t P /E ratio = 12.5 = O.OB or S%

(;,1
1
DPS
o·lVI·dend payout ratio =
EPS x 100 =
7 SO
-to
x 100 = 75%

Market price of the share (P) as per Walter's Model:

( !_] (E-D) (0.lOJ

:t• p = E+ kt _ 7.50 ~ (10-7.50)
,!
t
kt kt - o.~ + o.~ = , t32.s1
(.ii' The the pn'ce 0 f th L--
,, company's dividend payout ratio will not affect es.1ld.Cewhen kt =r
• il,m 1
,~. w P/E ratio = 10% or P/E = 10

1 = .!__ =O 125 12
(iit) HP/E=B thenk,= 8 • or -S % and r (given) = 10%
P /E ratio
el the • •
When k, > r, then according to Walter's mod whe n D /P ratio is 100 '-
100 {nee of the share is maximum
Hence, optimum payout ratio for the firm will be
 •J'<!lrket price of the share when D/P ratio is 100 %:
~tionof 1v1,a
p = 10 + (~)(10-10 )
0.125 =' 80.
0.125 .
t,tition . A company earned a net profit of, 20,00,000 and it has 2,00,000 equity shares. Dividends
16
,Ufd • 000• Find the_ market value of the share according to Walter's model wh
·dare'\ 4,00'
"':: tSo/o and rate of return r-:- 140Yo. What will ~e the optimum payout ratio. Fmd the marketen
• • • • cost of cap1•tat
price of the share
~hell dividend is at the optimum payout ratio. What would be the minimum price of the share and at what
situation? [B.Com(H) Delhi Univ. 2017)

20,00,000
EPS = 2,00,000 =' 10, DPS = 4,00,000 =' 2
Solution: Workings: 2,00,000
Calculation of market price of the share as per Walter's Model when o =, 2:

o+(;,)<E - D) 2 + 0.14(l0- 2)
P = k, ⇒ 0-1~18 =t 45.68
In the present question r < k~ price will be maximum when DIP ratio is 100%. Hence optimum payout
ratio is 100%. Price of the share at this payout is: •
0 14
10 + • (10-10)
P = 0.lS =' 55.55
0.18
Minimum price of the share would be when DIP ratio is 'O'

14
0 + 0 • (10-0)
p = 0.l8 =, 43.21
0.18

Dblstration 1~. Assuming that rate of return expected by investor is 11%; internal rate of return is 12%, and
earning per share1s , 15. Calculate price per share by 'Gordon-model' if dividend payout ratio is 10% and 30%.
[C.S. Final June 2005]

p = E(l-b)
Solution: According to Gordon's Model: kt -br

Where, P = Market price of equity share,

E =Earnings per share,
r = Rate of return on investment
b =Retention ratio (1-Payout ratio),
kt = Cost of equity capital,
br = Growth rate of the firm
p = 15(1-0.9) = 1.5 = , 750
Whftl DIP Ratio is 10% (retention ratio 90%): 0.11-0.9 X 0.12 0.002

p = 15(1-0.7) = 4.5 = t. 173.08

When DIP Ratio is 30% (retention ratio 70%): • 0.11- 0.7 X 0.12 0.026
 of, 10_ ea~. ~te of return on
!llutr11tion_ 18. RS Ltd. investe d , 50,00,000 in 5,00,000 equity shares
capitalization rate is 12%, .
invest ment JS 18% and retention ratio is 60% of its earnings. Uthe approp riate
, ,•
(1) What would be the price as per Gordo n's model?
(ii) What would be the priCE; if the company has payou t ratio of 70% and 200/o?
E (1-b) 18 ,
, = 1.8
Solutio n: According to Gordo n's Model: P= kt _ br , where E = EPS = 10 x 100

P= 1.8 (1 - 0.6) = 0.72 = f 60

(11 Whffl Rdmt ion Ratio is 60% (DIP ratio 40'%,): 0.12-( 0.6 X 0.18) 0.012

18 1 26
P= • (l-0.3 ) - • =, 19.09
(ii) (a) Whm Retention Ratio is 300/4 (DIP ratio 70%): 0.12-( 0.3 X 0.18) 0.066

p = 1.8 (1-0.8 ) = 0.36 f(

(b) Whm Retmt ion Ratio is 80% (DIP ratio 20%): 0.12 -(0.8 X 0.18) (-)0.02 4 = -)lS
share price can not be
In this case, price of the share will be f (-) 15, which is not possible. Here the
ve of one of the assumption of
calculated with this formula because g > kt (14.4% > 12),which is voilati
Gorden's model.
products, has been paying
Ill,,.tr11tion 19. Radiant Corporation, a market leader dealing in refrigeration
average has been 12%. The
dividend consistently over last several years. The growth rate of divide nd on an
capitalisation rate of Radiant Corporation is 16%.
logy for a new refrigerant
Consistent with its developmental philosophy, Radiant Corporation acquired a techno
in earnings and dividends as
that called for huge investment but offered a marke t potential of growth of 14%
well.
a measu re of good corporate
The manag ement decided to skip the divide nd for next three years. However, as
re-commence in 4 years from
governance and to reassure the investors, it announ ced that the divide nd would
think would be the impact
now at f12 only and would offer better growth of 14% instead of 12%. What do you
t of new project and resultant
on the price of shares of Radiant Corporation in the marke t of the announ cemen
[B.Com(H), Delhi Univ.2020]
postpo nemen t of dividend, assuming Gordon Assumptions?
Solution: 0) Calculation of market price of the share as per existin
g policy :
•
Curren t Dividend (assumed) D0 = f12
Growt h Rate (g) = 12%
Equity Capitalisation Rate( Ke) = 16%
D1 D0 (1 + g) 12 (1 + 0.12)
_ g - ke _ g ⇒ 0 _16 _ 0.12
= f336
Curren t marke t price of the share: as per Gorde n Model: P0= kt

(ii) Calculation of market price of the share as per the propo sed
: Divide nd will not be paid for first
policy
rate of 14%.
three years and its payme nt shall commence from 4th year at , 12 with an increased growth
Ds D, (1 + g) 12 (1 + 0.14)
P, = ke - g = ke - g ⇒ 0.16 - 0.14 = f 684
ed policy: = f684x PVIF'c16~
Calculation of the presen t value of the marke t price of the share under propos
.,...,
= f684x 0.552 = f377.57
, hence this can be adopted.
1he~ •ent value of the marke t price of the share under propos ed policy is higher
~ ___,JO. following information is available for K music company,
r,:~.__.., shate is , 5.00. Rate of return required by shareholders = 16%
~per t Gordon valuation model holds, what rate of return sh Id be .
~ t : inarkel price is ' 50. When the dividend payout is 40%. ou earned on mvestments to
-_,- ....,. Gordon's Model: P = ! l - I,) ⇒ 50 = S(l - 0.6) ⇒ 50
• 2
._LdlJ,11: As r-
~-- t - br 0.16-0.6r o.16 - 0.6r
50(0.16- 0.6r) = 2 ⇒ 8 - 30r = 2

(-) 30r = 2-8 -6

⇒ r= =-i) =0.20 or 20%

,n,st,,tio" 21. Using the following, find the price of a share and value of the firm using Golden's model :
EaffUllg per share f 12
. Equity capitalization rate 20%
Jntemal rate of return 16%
Retention rate 75%
• Number of shares oustanding 1,00,000
What will be the price and value of the firm if equity capitalization rate and internal rate of return are
mersed?
Solman:
Calculation of market price of the share and value of the firm using Gordon's Model: •
mWhen retention ratio is 75% (Payout ratio is 25%),Ke = 20%, r = 16%.
P = _E_(1_-_b)
'
12 (1-0.75)
ke -br 0.20-(0.75 X 0.16)

3 3
_ --- = - ='37.50
0.20- 0.12 0.08
Value of firm= No. of equity shares outstanding x market price per share
= 1,00,000 X '37.50 =' 37,50,()()()
fil) When retention ratio is 75% (Payout ratio is 25%),Ke = 16%, r = 20%. (if Ke & rare reveraed)

E (1-b) 12 (1-0.75)
P = - - - =>--..;...._---
kt -br 0.l 6 - (0.75 X 0.20)

3 3 ,
~--- - - -,300
= 0.16-0.15 - 0.01 -
Value of finn = No. of equity shares outstanrui:'g x market price per share
= 1,00,()()() X ' 300 = ' 3,00,()(),()()()

. . .