TYBAF SEM V FM Dividend Policy BR

The Term ‘’ Dividend’’ usually refers to a cash distribution of earnings. It is nothing but a part of
profit (earning per share) which company decides to share with its shareholders in form of cash on a
regular basis, usually annually/semi-annually. Dividend refers to that portion of a firm’s earning
which is distributed among shareholders.

BASICS OF DIVIDEND
Dividends are paid out of profits. These could either be profits of the current year or
the accumulated profits of the past. Dividends are paid quarterly, half yearly or annually.
Concept Formula Explanation

Dividend 𝑫𝑷𝑺 Dividend is expressed as a percentage of face

DR =
𝑭𝑽
Rate value and is referred to as dividend rate.

Dividend Per Share 𝑬𝒒𝒖𝒊𝒕𝒚 𝑫𝒊𝒗𝒊𝒅𝒆𝒏𝒅

DPS = 𝑵𝒐. 𝒐𝒇 𝑬𝒒𝒖𝒊𝒕𝒚 𝑺𝒉𝒂𝒓𝒆

Dividend 𝑫𝑷𝑺 When the dividend amount is expressed as a

DY = 𝑴𝑷𝑺 x 100
Yield percentage of market prices, it’s
called dividend yield.

Dividend 𝑫𝑷𝑺 When expressed as a percentage of earnings it

DPR = 𝑬𝑷𝑺 x 100
Payout ratio is known as dividend Payout.
OR
1 – Rate of Retention

Earning Per Share 𝑬𝑨𝑻 − 𝑷𝒓𝒆𝒇𝒆𝒓𝒆𝒏𝒄𝒆 𝑫𝒊𝒗𝒊𝒅𝒆𝒏𝒅

EPS =
𝑵𝒐.𝒐𝒇 𝑬𝒒𝒖𝒊𝒕𝒚 𝑺𝒉𝒂𝒓𝒆

Earning 𝑬𝑷𝑺 When EPS is expressed in terms of MPS it is

EY =
𝑴𝑷𝑺
Yield known as earnings yield

Price Earning Ratio 𝑴𝑷𝑺

P/E Ratio =
𝑬𝑷𝑺

WALTER’S MODEL
Walter’s model is based on the following assumptions:
1. The firm finances all investment through retained earnings; that is debt or new equity is not
issued;
2. The firm’s internal rate of return (r), and its cost of capital (k) are constant;
3. All earnings are either distributed as dividend or reinvested internally immediately
4. Beginning earnings and dividends never change. The values of the earnings per share (E), and the
divided per share (D) may be changed in the model to determine results, but any given values of E
and D are assumed to remain constant forever in determining a given value.
5. The firm has a very long or infinite life.

Walter’s Model
𝑹𝒂 𝑫 𝑹 𝑹
𝑫+ (𝑬−𝑫) + (𝑬−𝑫) 𝑫+ (𝑬−𝑫)
𝑹𝒆 𝑲𝒆 𝒌𝒆 𝑲𝒆
P= 𝑹𝒄
OR 𝑲𝒆
OR 𝑲𝒆

P : Market price per share of common stock

D : Dividend per share
E : Earnings per share
E-D = Retained Earning per share

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TYBAF SEM V FM Dividend Policy BR
Ra : Rate of return on Investment
Rc : Cost of Equity Capital/ Market capitalization rate.
VALUE OF FIRM = MPS * no of shares

Walter’s view on optimum dividend payout ratio where firms value is highest:
i. R > K (12% > 10%) or Ra > Rc = firm earn higher IRR than cost of Capital
⮚ Dividend Payout ratio = 0%
⮚ Full amount of earning must be retained in company
⮚ Then value of firm is increased.

ii. R < K ( 8% < 10%) or Ra < Rc = the cost of capital is more than IRR
⮚ Dividend Payout ratio = 100%
⮚ Full amount of earning be distributed to shareholders
⮚ Then value of firm is increased.

iii. R = K (10% = 10%) or Ra = Rc = IRR of the firm is equal to its cost of capital
⮚ Dividend Payout ratio = tumhari marzi
⮚ Then value of firm is increased.

GORDON’S MODEL
Another theory, which contends that dividends are relevant, is the Gordon’s model. This model
which opines that dividend policy of a firm affects its value of the share and firm is based on the
following assumptions:
(a) The firm is an all equity firm (no debt).
(b) There is no outside financing and all investments are financed exclusively by retained earnings.
(c) Internal rate of return (r) of the firm remains constant.
(d) Cost of capital (k) of the firm also remains same regardless of the change in the risk complexion
of the firm.
(e) The firm derives its earnings in perpetuity.
(f) The retention ratio (b) once decided upon is constant. Thus, the growth rate of firm (g) is also
constant (g=br).
(g) ke >g.
(h) A corporate tax does not exist.
Gordon used the following formula to find out price per share:
Gordon Model
𝑫𝟎 (𝟏 + 𝒈) 𝑫𝟎 (𝟏 + 𝒈) 𝑫𝟏
P0 = 𝑲𝒆 − 𝒈
= 𝑲𝒆 − 𝒃𝒓
=𝑲
𝒆− 𝒈

P0 = Current Market Price of Shares

D0 = Current Year’s Dividend
D1 = Expected Dividend
Ke = Cost of Equity Capital/ Expected rate of Return
g = Expected future growth rate of dividends.

OR

𝑬𝟏 (𝟏−𝒃)
P0 =
𝑲𝒆 − 𝒃𝒓
P0 = Current Market Price of Shares
E1 = Expected Earning Per Share
b = Retention Ratio

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TYBAF SEM V FM Dividend Policy BR
1-b = Dividend Payout Ratio
Ke = Capitalisation rate/Cost of capital
br = g = Growth Rate of earnings and Dividend
Where, P = Market price of a share
E = Earning per share
b = Retention ratio or percentage of earnings retained or (1 – Payout ratio)
(1 - b) = Dividend Payout ratio, i.e., percentage of earnings distributed as dividend

Modigliani And Miller’s Approach (M M Hypothesis)

The fundamental premise of this theory is that the price of the shares of a firm is determined by its
earning potentiality and investment policy and never by the pattern of income distribution. The
logical put forward in support of this theory is that only increase in shareholders wealth resulting
from dividend payments will exactly offset the effect of raising additional capital.
Proof for M. M. Hypothesis:
According to M. M. Hypothesis, the market value of a share at the beginning of the period is equal to
the present value of dividends paid at the end of the period plus the market price of the share at the
end of the period. MM Dividend theory is irrelevancy Theory

Modigliani an Millers Model (MM Model)

1. P1 = P0(1+Ke)-D1

P0= Prevailing market price of a share

D1 = Dividend to be received at the end of the period one
P1= Market price of share at the end of period one
Ke = Cost of equity capital

2. Computation of the number of new shares to be issued

No. of Shares
𝑰−(𝑬−𝒏𝑫𝟏 )
N1 = 𝑷𝟏
N1 = Number of shares to be issued
P1 = Price at which new issue is to be made
I = Amount of investments required
E = Total net profit of the firm during the period
D = Total dividend paid during the year.

𝑷𝟏 + 𝑫𝟏 (n+n1)P1 – I + E
3. Value of the firm = P0 = 𝟏 + 𝑲𝒆
OR = 𝟏 + 𝑲𝒆

E = Total earnings
N = Existing number of shares

Particulars If Dividend is declared If Dividend is not declared

Net Income
Less: Dividend paid
Retained Earnings
New Investments
Amount to be raised by issue of new shares
(New Investments – Retained earning) = a
Market price per share = b
New Shares to be issued = a/b

Existing Shares

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TYBAF SEM V FM Dividend Policy BR
Add: New Shares issued
Total Number of Shares at the end
X Market Price per share
Total Market Value of Shares at the year end

Graham DODD Model

This model postulates that the market prices of a share is a function of its dividends and earnings.
However, the model assigns higher weightage to dividends as against retained earnings. The equity
valuation model proposed by them is as follows.
P = m (D + E/3)

P is the Market price per share

M is the multiplier
D is the dividend per share
E is the earnings per share

Q.1 M Ltd. has total investment of ₹.15,00,000 assets and ₹.1,50,000 outstanding equity shares of
₹.10 each. It earns a 15% rate of interest on investment. If the appropriate discount rate is 10%
determine the price of the share using Gordon model. What shall happen to the price if the company
has a Payout of 60% of 40%.

Q.2 The rate of return expected by investors of ABC Ltd. is 11% internal rate of return is 12% and
earning per shares is ₹ 15. Calculate the price per shares by Gordon approach method if dividend
Payout ratio is 20% and 40%

Q.3 Zee Ltd. has paid dividend of ₹.10 per shares last year. The estimated growth of dividend from
the company is estimated to be 15% p.a. determine the estimated market price of the equity shares
if the growth rate of dividend.
I. Increase by 10%
ii. Decrease by 5%
The required rate of return on equity is 20%

Q.4 Max Ltd. provides you with following information

Growth rate=2%
Dividend Payout=40%
Face value of shares =₹10
Return on equity capital=15%
Find out price of shares as per Gordon model.

Q.5 The earnings per shares of a company is ₹ 8 and the rate of capitalization applicable is 10%. The
company has before it an option of adopting (i) 50% (ii) 75% and (iii)100% dividend Payout ratio.
compute the market price of the company quoted shares as per Walters model if it can earn a return
of (a)15% (b) 10% and (c)5% on its retained earnings

Q.6 Venus ltd. earns ₹.8 per shares which is capitalized at 10% and has return on investment of 15%
p.a. determine optimum Payout ratio and price of the shares using Walter dividend policy model.

Q.7 Following are details regarding three companies red ltd. yellows ltd. and green ltd.
Red Ltd. Yellow Ltd. Green Ltd.
r=15% r=5% r=10%
ke=10% ke=10% ke=10%
E=₹ 8 E=₹ 8 E=₹ 8

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TYBAF SEM V FM Dividend Policy BR
Calculate the value of an equity shares of each of these companies applying Walter formula when
dividend payment ratio D/P ratio (a) 25% (b)50% (c)75%
What conclusion do you draw.

Q.8 Bajaj ltd. has been following dividend policy as per Walter model. The estimated earnings of
current year of the firm is ₹.10,00,000. It is estimated that the firm can earn 2,00,000, if the profit
are retained fully. Return on investment is 15%. The firm has 1,00,000 equity shares. Find out
1. Dividend Payout ratio in order to maximise wealth of shareholder
2. Current market price of shares
3. Earnings per shares

Q.9 From the following information find out the

a. Market value of equity shares
b. Dividend Payout ratio
Use Walter model and find out optimum dividend Payout
Earnings of the company ₹ 10,00,000
Dividend paid ₹ 6,00,000
No. of share outstanding 2,00,000
Price earnings ratio 6
Rate of return on investment 15%
Cost of capital 12.5%

Q.10 From the following information find out: -

a. What should be the market value per share as per Walter model.
b. What is the optimum dividend Payout ratio as per Walter model.
c. Market value per shares for the same
Net profit for equity shareholder =₹ 10,00,000
Dividend pet shares =₹.5
No. of shares =1,00,000
Equity capitalisation rate =15%
Rate of return=18%

Q.11 From the following information ascertain whether the firm is following an optimum dividend
policy as per Walter model.
Total earning ₹ 6,00,000
No. of shares 60,000
Dividend paid ₹ 4,50,000
Price earnings ratio 12.5%
Rate of return 10%
The firm is expected to maintain rate of return on fresh investment
What should be the P/E ratio at which the dividend policy will have no effect on the value of the
shares

Q.12 Ajay ltd. has recorded an EPS of ₹.12 for 2016.17 the company follows a fixed dividend Payout
ratio of 50% if the multiple for the industry is 14, compute the expected market price for the shares
based on the graham- Dodd model

Q.13 Agile ltd. belong to risk class of which the appropriate capitalization rate is 10%.it current has
1,00,000 shares selling at ₹ 100 each. The firm is contemplating declaration of a dividend of ₹ 6 per
shares at the end of the current fiscal year which has just begun. Answer the following question based
on Modigliani and miller model and assumption of no taxes
i. What will be the price of the shares at the end of the year if a dividend is not declared
ii. What will be the price if dividend is declared

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iii. Assuming that the firm pays dividend has net income of ₹ 10lakhs and makes new investment of
₹.20 lakhs during the period how many new shares must be issued

Q.14 Mehta ltd. has 1,60,000 shares outstanding. The market price of shares is ₹.10 each. The
company expected a net profit of ₹.4,80,000 during the year end and a capitalised rate (Ke) is 20%.
The company is considering dividend of ₹.1 per shares for the current year at the end of the year
Find out
What will be the price per shares
I. If dividend is paid
ii. If dividend is not paid

Q.15 Zinc ltd. has outstanding 2,40,000 shares selling at ₹.20 per shares. The company wants to earns
net profit of ₹.10,00,000 during the year end. The company decided to pay dividend of ₹.3 per shares
at the end of the year
The capitalisation rate of risk class of the company is estimated at15%
Find out the following
I. Price of the shares if dividend is paid
ii. Price of the shares if dividend is not paid
iii. How many new shares must company issues if the dividend is paid for the investment of
₹.12,00,000