Chapter 17: Dividend Policy

Problem 1

EPS (Rs) 10
Internal rate, r 15%
Payout, p 40%
DPS (Rs): 10 × 40% 4
Growth, r(1 - p) = 15% (1 – 0.4) 9%
Required rate, k 10%
Share price:
Walter's model:
D PS r (E P S − D P S ) / k 130
+
k k
Gordon's model:
D PS 400
k − rb

Problem 2

Investment (Rs crore) 30

No of shares (crore) 0.3
Investment per share (Rs) 100
Profitability rate, r 20% 15% 10%
Capitalisation rate, k 12.50%
EPS (Rs) 20 15 10
Walter's model:
D PS r (E P S − D P S )/ k
+
k k
r>k r>k r<k
Optimum payout 0% 0% 100%
DPS (Rs) 0 0 10
Share price (Rs) 256 144 80

Problem 3

EPS (Rs) 10
Capitalisation rate, k 10%
Retention, b 40%
Internal rate, r 15% 10% 5%
DPS (Rs): EPS (1 – b) = 10 (1 - .4) 6
Growth, g = rb 6% 4% 2%
Share price:
Walter's model (Rs) 120 100 80
Gordon's model (Rs) 150 100 75

Problem 4

No of shares (lakh) 50
Market price, P0 (Rs) 120
Total share value (Rs crore) 60
DPS (Rs) 10
Total dividend (Rs crore) 5
Capitalisation rate 10%
Profits (Rs crore) 9
New investment (Rs crore) 6.6
MM model:
Market price, P1
 No dividends (Rs): P1 = P0(1+k) 132
Dividends paid (Rs): P1 = P0(1+k) - DPS 122
Funds needed (Rs crore): 6.6 - (9 - 5) 2.6
No of new shares: 2,60,00,000/122 213,115

Problem 5

Number of shares (crore) 0.1

New investment (Rs crore), I1 5
Profits (Rs crore), X1 1
Expected price, P1 120
Discount rate, k 10%
External funds (Rs crore): 5 crore - 1 crore 4
New shares (crore): 4 crore/120 0.033
Total shares (crore): [0.10 + 0.033] 0.1333
MM model:
Current share price (Rs):
( n + m ) P1 − I 1 + X 1
P0 =
n (1 + k )
( 0 . 10 + 0 . 033 )120 − 5 + 1 108.72
P0 =
0 . 1 (1 . 10 )

Problem 6

The current share price and growth rate are as follows:

5
P 0 = = Rs 125
0 . 15 − g
18 . 75 − 5
g = = 0 . 11
125

To compensate for the internal funds via retained earnings, the company will have to issue new shares. This will cause decline in the
dividend growth rate by (retained earnings to current price) 5/125 = 4%. This implies that the current shareholders will be sacrificing
4% each year to receive higher dividends. Thus the current share price remains:

10
P0 = = R s1 2 5
0 .1 5 − ( 0 .1 1 − 0 . 0 4 )

Problem 7

Share capital (Rs crore) 12.5

Reserve (Rs crore) 7.5
Net worth, NW (Rs crore) 20
PAT (Rs crore) 1.85
Dividends (Rs crore) 1.5
P/E ratio 13.33
Number of shares (crore): N = 12.50/10 1.25
EPS (Rs): PAT/N 1.48
Current share price (Rs): EPS × P/E ratio 19.73
ROE: PAT/NW 9.25%
DPS (Rs): 1.50/1.25 1.2
Retention: (PAT - Div.)/PAT 18.92%
Growth: Retention × ROE 1.75%
Required rate: DPS/P0 + g 7.83%
Share price: Walter's model 19.55
Share price 100% retention: Walter's model* 22.33

Under Walter’s model, when internal return is more than the required rate (r>k), the share
price will be maximum if 100% retention policy is followed.
Problem 8

Capital expenditure (Rs crore) 35

Project NPV (Rs crore) 25
Dividend (Rs crore) 20
Internal funds (Rs crore) 10
Current share price (Rs) 25
Number of shares (crore) 5
Current value of shares (Rs crore): 5 × 25 125
Value after capital expenditure (Rs crore): 125 + 25 150
Share price without dividend payment: 150/5 30
Share price with dividends paid (Rs): (150 - 20)/5 26
Funds needed if dividends paid (Rs crore): [35 + 20 - 10] 45
New shares (crore): 45/26 1.73
Funds needed if dividends not paid (Rs crore): [35 - 10] 25
New shares (crore): 25/30 0.83

Problem 9

Company X does not pay any dividend and its share price after a year is expected to be Rs 115. Thus its total before tax
payoff is: 0 + 115 = Rs 115. Since company Y is identical to company X, we expect that it will have the same total
before tax payoff of Rs 115 of which Rs 10 will come from dividend. Thus Y’s share price after a year is expected to be
Rs 105. Since both company’s have same risk, their after-tax return should be the same. Thus Y’s current share should
be such that its shareholders earn an after-tax return equal to X’s shareholders.

Co. X Co. Y
Current share price: P0 100 96.96
Price expected after one year 115 105
Expected dividend after one year 0 10
Expected capital gain 15 8.0
Total before-tax payoff: DPS1 + P0 115 115.0
Before-tax return 15% 19%
Dividend income tax, Ti 35% 35%
Capital gain tax, Tc 0% 0%
After-tax payoff: DPS1(1-Ti) + (P1-P0)(1-Tc) 115 111.5
After-tax return, r 15% 15%

Problem 10
A B
Current share price 50.53 48.42
Price expected after one year 60 50
Expected dividend after one year 0 10
Expected capital gain 9.47 1.58
Total before-tax payoff: TPayoff = P1 + DPS1 60.00 60.00
Before-tax return 18.8% 23.9%
Dividend income tax, Ti 40% 40%
Capital gain tax, Tc 20% 20%
After-tax payoff: Tpayoff -DPS1 × Ti + (P1-P0) × Tc 58.11 55.68
After-tax return, r 15% 15%

Problem 11

X Y Z
Dividend 0 5 10
Capital gain 10 5 0
Current share price 60 60 60
Before-tax total payoff 60 60 60
Dividend income tax 50% 50% 50%
Capital gain tax 20% 20% 20%
After-tax payoff 58.00 56.50 55.00
Expected after-tax yield 12% 12% 12%
Share price 51.79 50.45 49.11