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Problem No: 1

The document presents a problem involving ABC Ltd, a company with a capitalization rate of 10% and 5,000 outstanding shares priced at Rs. 100 each. The company is considering declaring a dividend of Rs. 6 per share and expects net income of Rs. 50,000. It has a proposal to invest Rs. 100,000. Under the MM hypothesis, the payment of dividends does not affect firm value. The value is calculated as Rs. 5,00,000 whether dividends are paid or not.

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Siva Sankari
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67 views

Problem No: 1

The document presents a problem involving ABC Ltd, a company with a capitalization rate of 10% and 5,000 outstanding shares priced at Rs. 100 each. The company is considering declaring a dividend of Rs. 6 per share and expects net income of Rs. 50,000. It has a proposal to invest Rs. 100,000. Under the MM hypothesis, the payment of dividends does not affect firm value. The value is calculated as Rs. 5,00,000 whether dividends are paid or not.

Uploaded by

Siva Sankari
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
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Problem No: 1

ABC Ltd belongs to a risk class for which the appropriate capitalization rate is 10%. It
currently has outstanding 5,000 shares selling at Rs.100 each. The firm is contemplating the
declaration of dividend of Rs.6 per share at the end of the current financial year. The company
expects to have a net income Rs.50,000 and has a proposal for making new investments of
Rs.1,00,000. Show that under the MM hypothesis, the payment of dividend does not affect the
value of the firm.

(A) Value of the firm when dividends are paid:


(i)
Price of the share at the end of the current financial year
P1 = Pn (1+ke)-D1
= 100(1+0.10)-6
= 100 x 1.10-6
= 110 6 = Rs.104
(ii) Number of shares to be issued.
M

(iii)

I (E-nD1)
------------P1

1,00,000 (50,000-5,000x6)
-----------------------------------104
=
80,000
--------104

Value of the firm


np = (n+m)P1 (I-E)
-------------------------1+ke

104 (1,00,00050,000 )
(5,000 80,000
104 )
1+ 0.10

5,20,000+80,000 104

( 50,000 )
104
1
=
1.10

6,00,00050,000
1.10

5,50,000
1.10

= Rs.5,00,000.

(B) Value of the firm when dividends are not paid:


(i)Price per share at the end of the current financial year.
P1=P0(1+ke)-D1
=100(1+0.10)-0
=100x1.10 = Rs.110
(ii)number of shares to be issued
m=

I ( En D 1 )
P1

1,00,000(50,0000)
110

50,000
110

(iii)value of the firm


nP0 = (n+m)P1 (I-E)
-------------------------1+ke

1.10( 1,00,00050,000 )
(5,000 50,000
110 )
1+0.10

5,50,000+50,000 110

( 50,000 )
110
1
=
1.10

6,00,00050,000
1.10

5,50,000
1.10

= Rs.5,00,000.

Hence, whether dividends are paid or not, the value of the firm remains the same Rs.5,00,000.

Solution:
(i)price per share when dividends are paid
P1=P0(1+ke)-D1
=10(1+1.5)-2
=11.5-2 = Rs.9.5
(ii)price per share when dividends are not paid:
P1=P0(1+ke)-D1
=10(1+1.5)-0
=Rs.11.5
(iii)number of new equity shares to be issued if dividend is paid
m=

I ( En D 1 )
P1

2,00,000(1,10,00050,000 2)
9.5

1,90,000
9.5

= 20,000 shares.

3.Solution:

r ( ED )
ke
P= D +
Ke
ke
Effect of dividend policy on market price of shares
(i)r=12%,

(ii)r=8%, (iii)r=100

(a) when dividend pay out ratio is 0%

0.12 ( 500 )
0
0.10
P=
+
0.10
0.10

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