Gordon Model

P0 = {D0(1+g)}/(k-g)

P0 = D1/(k-g)

Walters Formula
150
P= D +(E – D) * (r / Ke)
Ke
D Dividend Per Share
E EPS
r Rate of Return
Ke Cost of Equity

M & M Approach
P0 = (D1 + P1 )/ 1 + Ke
EBT 8400000
Tax @ 30% 2520000
EAT/PAES 5880000
No. Of ES 100000
EPS 58.8

Dividend 3000000

%Payout 51.0%
%Retention 49.0%

DPS 30

Div Rate 300%

Div Yield 21%

 Walters
Given
EPS 10 P= D + (E – D) * r / Ke
Ke 10% Ke

Alternative I Alternative IV

Dividend Payout Ratio 0 Dividend Payout Ratio

Rate of return -- r 15% Rate of return -- r
Current Dividend (D) 0 Current Dividend (D)
Retained Earning (E-D) 10 Retained Earning (E-D)
Value of share 150 Value of share

Alternative II Alternative V

Dividend Payout Ratio 0 Dividend Payout Ratio

Rate of return -- r 10% Rate of return -- r
Current Dividend (D) 0 Current Dividend (D)
Retained Earning (E-D) 10 Retained Earning (E-D)
Value of share 100 Value of share

Alternative III Alternative VI

Dividend Payout Ratio 0 Dividend Payout Ratio

Rate of return -- r 5% Rate of return -- r
Current Dividend (D) 0 Current Dividend (D)
Retained Earning (E-D) 10 Retained Earning (E-D)
Value of share 50 Value of share
 Intepretations

Alternative VII 1) Situation I, IV and VII

50% Dividend Payout Ratio 100%

15% Rate of return -- r 15%
5 Current Dividend (D) 10
Value of the share is highest
5 Retained Earning (E-D) 0 when dividend payout ratio is
125 Value of share 100 lowest because r>Ke

Alternative VIII 2) Situation II, V and VIII

50% Dividend Payout Ratio 100%

10% Rate of return -- r 10%
5 Current Dividend (D) 10
Value of the share is not
5 Retained Earning (E-D) 0 affected irrespective of the
100 Value of share 100 dividend policy when R = Ke

Alternative IX 3) Situation III, VI and IX

50% Dividend Payout Ratio 100%

5% Rate of return -- r 5%
Value of the share is highest
5 Current Dividend (D) 10 when dividend payout ratio is
5 Retained Earning (E-D) 0 highest because r<Ke
75 Value of share 100
on I, IV and VII

f the share is highest

vidend payout ratio is
est because r>Ke

on II, V and VIII

of the share is not

d irrespective of the
d policy when R = Ke

on III, VI and IX

f the share is highest

vidend payout ratio is
est because r<Ke
Situation I Situation II
Dividend Payout ratio 50% Dividend Payout ratio 50%
Retained Profit Ratio 50% Retained Profit Ratio 50%
Capitalisation Rate (Ke) 15% Capitalisation Rate (Ke) 15%
Rate of return 20% Rate of return 15%
Growth rate (g) 10% Growth rate (g) 7.5%
Expected EPS 10 Expected EPS 10
Expected DPS (D1) 5 Expected DPS (D1) 5

Value of share 100 Value of share 66.66667

Situation IV Situation V
Dividend Payout ratio 75% Dividend Payout ratio 75%
Retained Profit Ratio 25% Retained Profit Ratio 25%
Capitalisation Rate (Ke) 15% Capitalisation Rate (Ke) 15%
Rate of return 20% Rate of return 15%
Growth rate (g) 5% Growth rate (g) 3.75%
Expected EPS 10 Expected EPS 10
Expected DPS (D1) 7.5 Expected DPS (D1) 7.5

Value of share 75 Value of share 66.66667

Situation III
Dividend Payout ratio 50%
Retained Profit Ratio 50%
Capitalisation Rate (Ke) 15%
Rate of return 10%
Growth rate (g) 5.0%
Expected EPS 10
Expected DPS (D1) 5

Value of share 50

Situation VI
Dividend Payout ratio 75%
Retained Profit Ratio 25%
Capitalisation Rate (Ke) 15%
Rate of return 10%
Growth rate (g) 2.50%
Expected EPS 10
Expected DPS (D1) 7.5

Value of share 60
Dividend Payout Ratio 0 Given
Rate of return -- r 12% EPS 10
Current Dividend (D) 0 Ke 10%
Retained Earning (E-D) 10
Value of share 120
Walters

P= D + (E – D) * r / Ke
Ke
Earning 500000 Walters
No of shares 100000
EPS 5 P= D + (E – D) * r / Ke
Div payout ratio 60% Ke
DPS 3
Rate of return - r 15%
Cost of capital 12%

Value of share 45.83333

Rate of return - r > Cost of capital

Optmum div payout ratio 0%
DPS 0

Value of share 52.08333

Earning 3,000,000 Walters
Less : Preference Dividend 1,200,000
Proft available 1,800,000 P= D + (E – D) * r / Ke
No of shares 300,000 Ke
EPS 6
Div payout ratio ?
DPS ? 42 = ((D+(6-D)*0.20/0.16)/0.16
Rate of return - r 20%
Cost of capital 16% 42*0.16 = ((D+(6-D)*0.20/0.16)

Value of share 42 6.72 = D + (6-D)*1.25

6.72 = D + 7.25 -1.25D

*0.20/0.16)/0.16
Rate of return 20%
Rate of dividend 18%
Face value per share 10
DPS 1.8
Payout ratio 36%
EPS = DPS / payout ratio 5
P/E ratio 7.25
Price per share 36.25

Walters

P= D + (E – D) * r / Ke
Ke

36.25 = (((1.8+((5-1.8)*0.20/Ke))/Ke)
Situation I Situation II
Cost of capital 15.50% Cost of capital
Growth Rate 5% Growth Rate
Dividend Per share 2 Dividend Per share

Value of share 20 Value of share

 Situation II
15.50% Cost of capital 15.50%
8.0% Growth Rate 3.0%
2 Dividend Per share 2

28.8 Value of share 16.48

 Rf 6%
Cost of capital 9.20% Rm -Rf 4%
Growth Rate 6% B 0.8
Dividend Per share 6
Ke = 6%+0.8*4
Value of share 198.75
((6*1.06)/(9.2%-6%))
 Expected EPS 18 P0 = D1/(k-g)
Div payout ratio 60%
Retention ratio 40%
Rate of return 20%
Growth rate 8%
Expected Dividend 10.80
(18 X 60%)
PART I PART II
90= 10.80 / (Ke -8%) Div payout ratio 100%

(Ke -8%) = 10.80/90 Expected Dividend 18

(Ke -8%) = 12% Retentin ratio 0

Ke 20% growth rate 0

Value of share 90
Situation 1 Situation 2

Dividend Paid Dividend Not Paid

P0 100 P0 100
D1 6 D1 0
P1 ? P1 ?

100 = (6+ P1) / 1+10% 100 = (Nil+ P1) / 1+10%

100 = (6+P1) / 1.10 100 = (0+P1) / 1.10

100*1.10 = (6+P1) 100*1.10 = P1

110 = (6+P1) 110= P1

P1 = 104
Computation of number of shares to be issued
Particulars If dividend is declared
Net income 1,000,000
Less : Dividend paid (6 X 100000) 600,000
Retained earnings 400,000
New investments 2,000,000
Amount to be raised by issue of new shares (a) 1,600,000
Market price per share (b) 104
Number of shares to be issued (a)/(b) 15384.62
Situation 1 Situation 1

Dividend Paid Dividend Not Paid

P0 100 P0 100
D1 5 D1 0
P1 ? P1 ?

100 = (5+ P1) / 1+10% 100 = (Nil+ P1) / 1+10%

100 = (5+P1) / 1.10 100 = (0+P1) / 1.10

100*1.10 =(5+P1) 100*1.10 = P1

110 = (5+P1) 110= P1

P1 = 105
Computation of number of shares to be issued
If dividend is If dividend is not
Particulars declared declared
Net income 500,000 500,000
Less : Dividend paid 250,000 0
Retained earnings 250,000 500,000
New investments 1,000,000 1,000,000
Amount to be raised by issue of new shares (a) 750,000 500,000
Market price per share (b) 105 110
Number of shares to be issued (a)/(b) 7142.86 4545.45

Verification of MM Dividend Irrelevancy Theory

Existing shares 50000 50000
Add : new equity shares 7142.86 4545.45
Total number of shares at the end (a) 57142.86 54545.45
Market price per share (b) 105 110
Total market value of shares at the year end(a)×(b) 6000000 6000000
Computation of number of shares to be issued
If dividend is
Particulars declared
Net income 250,000
Less : Dividend paid 125,000
Retained earnings 125,000
New investments 500,000
Amount to be raised by issue of new shares (a) 375,000
Market price per share (b) 105
Number of shares to be issued (a)/(b) 3571.43

Verification of MM Dividend Irrelevancy Theory

Existing shares 25000
Add : new equity shares 3571.43
Total number of shares at the end (a) 28571.43
Market price per share (b) 105
Total market value of shares at the year end(a)×(b) 3000000
If dividend is not
declared
250,000
0
250,000
500,000
250,000
110
2272.73

25000
2272.73
27272.73
110
3000000
 Situation a situation b
Debt 1.5 900000 720000 Debt
Equity 1 600000 480000 Equity
Total Cap 2.5 1500000 1200000 Total Cap

Last year Profits (2002-03) 1000000

Growth (6%) 60000 Year 2002-03
Normal profit (2003-04) 1060000 NP 1,000,000
DP ratio 25%
Normal Dividend 265000 Investment
 Situation a
3
1 500000
4 2000000

2003-04 2004-05
1,500,000

? 2,000,000
Question 17

Last year profit (2002-03) 1,000,000 Debt 3

Add: Normal increase @6% 60000 Equity 1
Normal profit (2003-04) 1,060,000 Total 4
Dividend payout ratio 25%
Normal Dividend (2003-04) 265000 Actual Profit (2003-04)
Investment
Actual Profit (2003-04) 1,500,000 Balance - Dividend
Dividend payout ratio 40%
Actual Dividend (2003-04) 600000 Debt 2
Equity 1
Total 3

Actual Profit (2003-04)

Investment
Balance - Dividend
 1,500,000
500000
2,000,000

ofit (2003-04) 1,500,000

500000
1,000,000

1,000,000
500000
1,500,000

ofit (2003-04) 1,500,000

500000
1,000,000
Debt 1.5 900000
Equity 1 600000 480000
Total Cap 2.5 1500000 1200000