Dividend Theories, 10.
15
C. ESSAY TYPE QUESTIONS
1. How far do you agree that dividends are irrelevant ?
2. There is strong view prevalent among financial experts that the irrelevant hypothe9sis urnderlying the
MM theoy of dividend distribution is out-dated and unsuited to present conditions. Do you agree with
this view? Discuss.
3. In Walter's approach, the dividend policy of a irm depends on availability of investrnert oggortunity
and the relationship between the firm's internal rate of return and its cost of capital. Discuss what are
the shortcomings of this view.
4, Discuss the theoriesof relevance of dividend as given by (i) Prof. Walte,and (i) Myron Gordon.
5. Critically examine the theory of irrelevance as given by Modigliani and Miller.
Exercises
Ex 1. The Asbestors Company belongs to a risk class of which the appropriate capitalisation rate
is 10%. It currently has 1,00,000 shares selling at 100each. The firm is contemplating the
declaration of a 6 dividend at the end of the current fiscal year, which has just begun.
Answer the following questions based on the MM model and the assumption of no taxes :
(a) What willbe the price of the shares at the end of the year if (i) dividend is not declared;
and (ii) if it is declared?
(b) Assuming that the firm pays dividend, has net income of R 10,00,000 and makes new
investment of 20,00,000 during the period, how many new shares must be issued ?
[Ans. (a) () 110;(i) 104 ;(b) 15,385 shares.]
Ex. 2. Omega Company has a cost of equity capital of 10%, the current value of the firm (v) is
20,00,000 @ 20 per share). Assume value for I (new investment); Y (earrings) and D
(dividends) at the end of the year as I = 6,80,000, Y=? 1,50,000 and D= 1 per share.
Show that under the MM assumptions, the payment of D does not affect the value of the
firm. [Ans. Value of Firm remains 20,00,000]
Ex. 3. The Apex Company which earns 5 per share, is capitalised at 10% and has a return on
investment of 12 %. Using Walter's model, determine:
) the optimum pay-out; and
(ii) the priceof share at this pay-out. [Ans. (i) 0% (i) T601
Ex. 4. The Agro-Chemicals Company belongs to a risk class for which the appropriateis
capitalisation rate is 10%. It currently has 1,00,000 shares selling at 100 each
The firm
contemplating the declaration of 5 as dividend at the end of the current financial year,
year, if a
which has just begun. What will be the price of the share at the end of the
on the basis
dividend is not declared ? What will be the price if it is declared ? Answer this
of MM model and assume no taxes. [Ans. (i)* 110; (iiR 105)
Ex. 5. The details regarding three companies are given below :
X Ltd. Y Ltd. Z Ltd.
=12% 6% 8%
8% 8%
ke-8%
E=10 10
Dividend Theories,
10.16
applying Walter's
Compute the value of an equity share of each of these companies 100%.
20%;(c) 60%; and (d)
equation when dividend pay-out ratio is (a) 0%;(b)
JAns. X Ltd. (a) 187.5 (b) ? 175 (c) 150 (d)?125;Y Ltd. (a) 93.75 (b)? 100 (c) F112s
(d) 125; Z Ltd.(a) 125 (b) 125(c) R 125 (d) ? 1251
Ex. 6. The earnings per share of a company are 16. The market rate of discount applicable to the
company is 12.5%. Retained earnings can be employed to yield a return of 10%. The
company is considering a payout of 25%, 50% and 75%. Which of these would maximise
the wealth of shareholders ? [Ans.75%]
Ex.7.] The earnings per share of a company are 10 and the rate of capitalisation applicable to it
is 10%. The company has before it the options of adopting a payout of 20% or 40% or 80%
Using Walter's formula, compute the market value of the company's share if the
productivity of retainedearnings is (i) 20%,(i) 10%, and (ii) 8%
What inference can be drawn fromn the aboye exercise.
[Ans. 180, 160, and 120; 100, 100, and 100 ;84, 88, and 961
Ex. 8. A company is expected to pay a dividend of 2 per equity share. The dividends are
expected to grow at the rate of 10%. Find out the share price today, if market capitalises
dividend at 30%. [Ans. 10]
Ex. 9. A company has a total investment of 5,00,000 in assets, and 50,000 outstanding ordinary
shares at 10 per share (par value). It earns a rate of 15% on its investment, and has a
policy of retaining 50% of the earnings. If the appropriate discount rate of the firm is 10%,
determine the price of its share using Gordon's model. What shall happen to the price of
the share, if the company has a payout of 80%. [Ans. 30, and 17.14]
Ex. 10. A company presently pays a dividend of Re. 1.00 per share and has a share price of
25.00. Ifthe dividend is expected to grow at a rate of 15% p.a. forever, what is the firm's
expected or requiredreturn on equity using adividend discount model approach?
[Ans. 19.6%1