Excel Applications in Dividend Decisions (Problems Taken from Prof. Surender Singh & Prof.

Rajeev Kaur's Book

"Financial Management")

Problem 1. (From BCH Book Illustration 3. Page 9.20)

Data:
EPS ₹ 10
P-E Ratio 10
Ke 10%
No. of Outstanding shares 20,000
Expected Dividend ₹ 5
Expected Net Income ₹ 200,000
New Investment ₹ 400,000
As per MM Approach, show that the payment of dividend does not affect the value of the firm. Use the above data to prove the statemen
Solution
Situation 1 When dividend is paid:

a) Market Price: P0 = D1 + P 1 5+P1 = P0 However, P0 =

1+Ke 1+0.10 =

P1 105 P1 = ₹ 105

b) Amount to be raised through issue of new equity shares

Amount to be raised by i = I-[E-rD1]

₹ 300,000

c) Number of new shares to be issued ₹ 2,857.14

d) Value of firm: rP0 = 1 X [( r+s )P1 -I +E]

1+Ke
 rP0 = ₹ 2,000,000.00

Situation 2: When Dividend is not paid

a) Market Price: P0 = D1 + P 1 0+P1 = P0 and P0 is 100

1+Ke 1+0.10
Therefore, P1 110
b) Amount to be raised by issue of new equity shares:
= I-[E-rD1]
₹ 200,000.00
c) Number of new shares: ₹ 1,818.18
d) value of Firm: rP0 = 1 X [( r+s )P1 -I +E]
1+Ke
₹ 2,000,000.00
Therefore, the value of firm remians the same
a to prove the statement.

EPS+P/E Ratio
100
 Problem 2 ( From BCH Book Illustration 6 Page 9.23). A textile company belongs to risk class for which the appropriate P/E ratio is 10. It currently has 50,00
outstanding shares selling at `100 each. The firm is contemplating the declaration of dividend of `8 per share at the end of current fiscal year which has jus
started. Given the assumptions of Modigliani and Miller, answer the following questions:
(i) What will be the price of the share at the end of the year (a) if dividend is not declared (b) if dividend is declared ?
(ii) Assuming that the company pays the dividend, has a net income of ` 5,00,000 and makes new investments of ` 10,00,000 during the period, how many
new shares must be issued ?
(iii) What will be the value of the firm (i) if dividend is declared (ii) if dividend is not declared.

Solution: Given:
P/E Ratio 10
No. of Outstanding sha 50,000
Price per share ₹ 100.00
Expected Net Income ₹ 500,000.00
New Investment ₹ 1,000,000.00 New Investment ₹ 1,000,000.00
Dividend intended to be paid ₹ 8.00
Ke = 1 0.1 10%
P/E Ratio
i) Price of the share at the end of the year if
a) dividend is not declared
P0 = D1 + P 1 100 = 0+P1 ₹ 110.00
1+Ke 1+10%
b) dividend is declared
P0 = D1 + P 1 100 = 8+P1 ₹ 102.00
1+Ke 1+10%
ii) Amount to be raised through issue of new equity shares when dividend is paid:
= I-[E-rD1] ₹ 900,000.00
Number of new shares to be issued: 8823.53
ii) Amount to be raised through issue of new equity shares when dividend is not paid:
= I-[E-rD1] ₹ 500,000.00
Number of new shares to be issued: 4545.454545
iii) Value of Firm:
a) when dividend is declared:
rP0 = 1 X [( r+s )P1 -I +E] ₹ 5,000,000
1+Ke
b) when no dividend is declared
rP0 = 1 X [( r+s )P1 -I +E] ₹ 5,000,000
1+Ke
Therefore, Value of firm remains unaffected irrespective of the fact whether company pays dividend or not
ratio is 10. It currently has 50,000
current fiscal year which has just

00 during the period, how many

P1 = 110

P1= 102
 Problem3. (FromBCH Book Illustration 10 Page 9.29) Following are the details regarding 3 companies
A Ltd B Ltd C Ltd
IRR (r)
Cost of Capital 15% 10% 8%
(Ke) 10% 10% 10%
Earning Per share ₹ 10.00 ₹ 10.00 ₹ 10.00
Using Walter model, calculate the effect of dividend payment on the value of share of the above companies under:
i) When no dividend is paid
ii) When dividend is paid @8Rs per share
ii) When dividend is paid @10Rs per share
Solution:
Market price of the share as per Walter Model:
D + ( r /Ke)(E-D)
Ke
A Ltd. B Ltd C Ltd
D/P Ratio P = ₹ 150.00 ₹ 100.00 ₹ 80.00
0%
0 150 100 80

80% P = ₹ 110.00 ₹ 100.00 ₹ 96.00

8
110 100 96
100% P = ₹ 100.00 ₹ 100.00 ₹ 100.00
10
100 100 100
Effects of Divided Policy:
(i) ‘A’ Ltd. is a “growth company”, Where r > ke. Therefore, to maximise the market price, the company 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 firm, where r = k. In this case D/P 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 < ke. 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 increase in payout ratio.
 (iii) ‘ C’ Ltd. is a “declining company”, Where, the rate of return is less than the cost of capital i.e.,
r < ke. 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 increase in payout ratio.
 Problem 4. ( From BCH Book Illustration 13 Page 30. The following information for the current year about XYZ Ltd. is available to you :

Earnings of the Firm ₹ 1,800,000.00

No. of Equity Share (N) ₹ 300,000.00
Amount of Dividend Paid ₹ 900,000.00
ROI 22.50%
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 ? If not, 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 ?
(iv) What should be the payout ratio if the firm wants to keep its share price at ` 55 ?
(v) When will the firm be indifferent about payment of dividend ?

Solution:
i) Price of share and value of firm using Walter model
EPS 6 6
Market price of the share as per Walter Model: D + ( r /Ke)(E-D)
Ke
Po 50
Value of the firm P0 X N ₹ 15,000,000

ii) Optimum payout ratio in case of Walter model should be 0. D + ( r /Ke)(E-D)

Market price of the share at 0 payout: Ke
60
Value of firm at 0 P0 X N
₹ 18,000,000.00
iii) Value of firm will be lowest at 100% dividend payout ratio.
iv) Payout ratio if firm's share price is 55 D + ( r /Ke)(E-D) = RS 55
Ke
(D+(C6/C7)(D11-D))/C7 = RS 55
1.5
v) Firm will be indifferent when payout ratio and cost of capital are equal
lable to you :

out ratio ?

DPS 3 3
 Problem 5 (From BCH Book Illustration 17 Page 9.33)Assuming that the rate of return expected by
investors is 11%, internal rate of return is 12% and earning per share is 15. Calculate price per share by
Gordon Model if C/P ratio is 10% and 30%

Solution:

Scenario 1 Scenario 2
EPS 15 15 Payout Ratio 10% 30%
Ke 11% 11%
r 12% 12%

b 90% 70%
br 10.8% 8.4%

Price per share as per Gordon Model: P= E(1-b)

Ke - br
P 750.00 173.08

₹ 750.00 ₹ 173.08