Dividend Decisions

(a)Win Some Ltd. is contemplating issue of shares for an expansion project :

Assuming that Modigliani Miller’s approach (theory of irrelevance of dividend to market value) is followed, you are required to calculate :

(i)Total number of shares at the end of FY.

(ii)The market value of the shares at the end of FY.

(ii)What is the rationale of stable dividend policy ?

Regular Dividend Policy means :

(A)Payment of low dividend per share constantly plus extra dividend in the year when the company earns high profit

(B)Reserve fund is created to pay dividend

(C)Investors get dividend at usual rate

(D)All of the above

Determine the Market price of share on the basis of Gordon’s Model using following information. EPS : ₹ 5, Dividend Payout - 35%, Capitalization rate 8%, rate of return on investment – 12%.

(A)₹ 875

(B)₹ 325

(C)₹ 450

(D)₹ 375

Which of the following form of dividend is not prevalent in India ?

(A)Cash dividend

(B)Bond Dividend

(C)Stock Dividend

(D)None of the above

Modigliani and Miller argued that the dividend decision :

(A)Is relevant as the value of the firm is not based just on the earning power of its assets

(B)Is irrelevant as the value of the firm is based on the earning power of its assets

(C)Is irrelevant as dividends represent cash leaving the firm to shareholders, who own the firm anyway

(D)Is relevant as cash outflow always influences other firm decisions

The market price of J Ltd. is ₹ 200 per share as per Gordon Model EPS is ₹ 20 per share. The cost of capital is 11%. The rate of return on investment is 12%. What is the retention ratio ?

(A)80%

(B)50%

(C)100%

(D)60%

The following information is available in respect of H Ltd. :

Based on Walter’s model, what is the approx. share price ( ₹ ), if the Dividend payout ratio is 50% ?

(A)42

(B)46

(C)58

(D)52

(b)ABD Limited has provided the following information :

Earnings per share = ₹ 25

Dividend per share = ₹ 9

Cost of capital = 12%

Internal rate of return (IRR) on investment = 16%.

You are required to compute the market price per share using :

(a)Gorden’s formula

(b)Walter’s formula.

A dividend policy that helps in creating confidence among the investors, stabilizes the market price of shares and helps in marinating the goodwill of the company is :

(A)Regular dividend policy

(B)Stable dividend policy

(C)Both (A) and (B)

(D)Neither (A) nor (B)

Which of the following dividend types is not prevalent in India ?

(A)Cash Dividend

(B)Bond Dividend

(C)Property Dividend

(D)Stock Dividend

According to the residual dividend theory, dividend payment is determined on the basis of :

(A)The availability of excess funds after all investment opportunities with positive net present value are undertaken.

(B)The preference of shareholder for a consistent dividend payout ratio

(C)The desire to maintain a stable dividend payout ratio regardless of investment opportunity

(D)The goal of maximizing shareholder wealth by paying out all available earning as dividend

Determine the market price of share of XYZ Ltd as per Gordon’s model, given that equity capitalisation rate = 11%, expected earning = ₹ 20, rate of return on investment = 10% & retention ratio = 30%.

(A)165

(B)175

(C)185

(D)195

The repurchase of stock is considered ............... decision rather than ............... decision.

(A)financing; an investment

(B)an investment; a financing

(C)a dividend; a financing

(D)an investment; a dividend

Ram Ltd is a listed company. Its ₹ 1 ordinary shares are quoted on the stock exchange. The Board of Ram Ltd. is aware that the market is expecting Ram Ltd. to pay a dividend of ₹ 90 lakh to be paid at the year end, but in order to fund the investment in an important new project, the Board is considering offering a scrip dividend of 1 share for every 10 shares held instead of a cash dividend. Profit after tax and interest is forecast to be ₹ 250 lakh in the current financial year, and Ram Ltd. equity comprises of :

Ordinary share capital (₹ 1 shares) ₹ 1,000 lakh

Reserves ₹ 350 lakh

Ram Ltd’s share price is ₹ 1.5 per share.

What is the approx. expected share price of Ram Ltd after the scrip dividend has been issued ?

(A)₹ 1.42

(B)₹ 1.28

(C)₹ 1.36

(D)₹ 1.45

When IRR is greater than ............, the price per share ............. and dividend payout is expected to ......... .

(A)Cost of equity capital, increases, decrease

(B)Cost of debt capital, decreases, increase

(C)Cost of capital, increases, decrease

(D)Cost of capital, decreases, increase

According to “Bird-in-hand Theory”, investors are ................ .

(A)Risk Averse and Put premium on certain return and discount on certain return

(B)Risk takers and Put premium on uncertain return and discount on certain return

(C)Risk neutral and put no premium or discount on return

(D)Risk Averse and put premium on uncertain return and discount on certain return

The MM hypothesis of the irrelevance of dividends is based on which of the critical assumption ?

(i)Investors can forecast future prices & dividends with certainty.

(ii)The firm has a given investment policy which does not change.

(iii)All financing is done only through retained earnings.

(iv)There are no taxes.

(v)Perfect capital market in which all investors are rational.

(A)(i), (ii) and (iii) only

(B)(iii), (iv) and (v) only

(C)(i), (ii), (iv) and (v) only

(D)(ii), (iii), (iv) and (v) only

Walter's Model suggests for 100% Dividend Payout Ratio when :

(A)r > Ke

(B)r = Ke

(C)r < Ke

(D)Ke = 0

The following inforrnation is available in respect of Sober Ltd. : No. of shares outstanding : 1 lakh; Earnings per share : ₹ 4; Equity capitalization rate : l2%, Rate of return on investment : l5%; you are required to calculate the Dividend payout ratio to keep the share price at ₹ 40 as per the Walter’s model.

(A)50%

(B)40%

(C)60%

(D)20%

The earning per share of a company is ₹ 25. Its internal rate of return is l5% and capitalization rate of the risk category to which it belongs is 12%. If the retention ratio is 100%, the approx. market price of the shares ac cording to Walter’s model will be ₹ :

(A)167

(B)260

(C)133

(D)208

Which of the following approach advocates irrelevance of dividend ?

(A)Walter’s Model

(B)Gordon’s Model

(C)M.M. Approach

(D)All of the above advocates relevance of dividend

The market price of A Ltd. is ₹ 200 per share as per Gordon Model. Earning per share is ₹ 20. Cost of capital is 11%. Rate of return on investment is l2%. What was the retention ratio ?

(A)25%

(B)50%

(C)75%

(D)100%

Which of the following forms of dividend is not prevalent in India ?

(A)Property Dividend

(B)Stock Dividend

(C)Bond Dividend

(D)Cash Dividend

Which of the following theories of dividend is set on the premise of irrelevance of dividend in firm’s valuation ?

(A)Walter’s Model

(B)Gordon’s Model

(C)M.M. Approach

(D)All the above advocates relevance of dividend in firm’s valuation

Which of the following is/are not a part of negative covenants in a Loan Agreement?

(A)Restrictions to pay commission to Promoters, Directors, Managers or any other person for furnishing the guarantee or indemnity for the undertaking

(B)Restrictions to pay dividend to the equity shareholders in case of default in payment of interest or repayment of principal

(C)Restrictions on creating a charge or lien on the assets of the undertaking

(D)None of the above

Which of the following is not a merit of Regular Dividend Policy?

(A)It helps in creating confidence among the investors

(B)It does not assist in stabilizing market value of related securities

(C)It assists in maintaining goodwill of the company

(D)It gives a regular income to the shareholders

Which of the following is/are criticism of Walter’s Model of Equity Valuation ?

(A)It mixes dividend policy with investment policy

(B)It is based on the unrealistic assumption that return on investment is constant

(C)It assumes that firm’s cost of capital or discount rate does not remain constant and changes directly with firm’s risk

(D)All of the above

A Ltd. invested ₹ 500 lakh in assets. There are 50,00,000 shares outstanding. The par value of share is ₹ 10. It earns a rate of 15% on its investment and has a policy of retaining 60% of the earning. Growth rate is .....................

(A)6%

(B)7.5%

(C)9%

(D)10%

A company earns ₹ 5 per share. The capitalization rate is 10% and rate of return on investment is 18%. What would be the value of share at optimum payout ratio ?

(A)₹ 70

(B)₹ 80

(C)₹ 90

(D)₹ 100

A Ltd. has 20,000 shares of ₹ 100 each. The company is contemplating to declare a dividend of ₹ 5 per share at the end of the current year. The capitalization rate of the company is 10%. Calculate the value of share if dividend is not declared.

(A)₹ 100

(B)₹ 105

(C)₹ 110

(D)₹ 115

What are the different options other than cash used for distributing profits to shareholders?

(A)Bonus shares

(B)Stock split

(C)Stock dividend

(D)All of the above

Modigliani and Miller, recognizing that dividends do somehow affect stock prices, suggest that positive effects of dividend increases are attributable :

(A)Directly to the dividend policy

(B)Directly to the optimal capital structure

(C)Not to the informational content but to the consistency in the payment of dividends

(D)Not to the dividend itself but to the informational content of the dividends with respect to future earnings

A Company has 5,000 shares of ₹ 100 each. The capitalisation rate is 12%. Income before tax is ₹ 2,00,000. Tax rate is 30%. Dividend pay-out ratio is 50%. Find Market Price Per Share (MPS) at the end of the current year based on MM approach if dividend is paid.

(A)₹ 101

(B)₹ 100

(C)₹ 99

(D)₹ 98

PQR company earns ₹ 10 per share, is capitalised at a rate of 10 per cent and has a rate of return on investment of 20 percent. If dividend payout ratio is 50%, what should be the price per share, according to Walter’s model ?

(A)₹ 200

(B)₹ 150

(C)₹ 125

(D)₹ 225

When the firm does not pay out fixed dividend regularly, the dividend policy is known as :

(A)Irregular

(B)Regular

(C)No immediate

(D)Liberal

From the following information find the market value per share as per Walter’s model :

Earnings of the Company ₹ 5,00,000, Dividend Payout ratio 60%, No. of shares outstanding 1,00,000, Equity capitalization rate is 12% and Rate of return on investment is 15%.

(A)45.83

(B)48.53

(C)49.27

(D)47.19

Modigliani and Miller argue that the dividend decision ..................... .

(A)Is irrelevant as the value of the firm is based on the earning power of its assets

(B)Is relevant as the value of the firm is not based just on the earning power of its assets

(C)Is irrelevant as dividends represent cash leaving the firm to shareholders, who own the firm anyway

(D)Is relevant as cash outflow always influences other firm decisions

Determine the market price of a share of XYZ Ltd. as per Gordon’s Model, given equity capitalisation rate = 11%, Expected Earning = ₹ 20, rate of return on investment = 10% and retention ratio = 30%.

(A)₹ 165

(B)₹ 175

(C)₹ 185

(D)₹ 195

A Company Ltd., has 50,000 shares outstanding. The current market price of the shares is ₹ 50 each. The company expects the net profit of ₹ 1,00,000 during the year and it belongs to a risk class for which the appropriate capitalisation rate has been estimated to be 25%. The company is considering dividend of ₹ 10 per share for the current year. What will be the price of the share at the end of the year, if the dividend is not paid ?

(A)₹ 60.5

(B)₹ 62.5

(C)₹ 72.5

(D)₹ 52.5

Which of the following statements is not true in the context of M-M’s dividend theory ?

(A)The firm operates in perfect capital markets

(B)All investors are rational

(C)There is no fixed investment policy of the firm

(D)The dividend policy of the firm is irrelevant

If a firm declared 25% dividend on share of Face Value of ₹ 10, its growth rate is 5%, and if the rate of capitalization is 12%, its expected price would be ₹ ......................... .

(A)31.25

(B)33.50

(C)36.00

(D)37.50

(c)Legal, Contractual and Internal Constraints and Restrictions needs to be considered while framing dividend policy.

(b)Regular dividend policy and Stable dividend policy

(e)The following information is available in respect of the rate of return on investment

(r), the capitalisation rate (Ke) and earnings per share (E) of X Ltd. :

r = 12%, E = 20.

Determine the value of shares, assuming the following :

D/P ratio = 10, Retention Ratio = 90, Ke = 20%.

(ii)X Ltd. belongs to a risk class for which the approximate capitalisation rate is 10%. It currently has outstanding 2,500 shares selling at ₹ 100 each. The company is contemplating the declaration of dividend of ₹ 5 per share at the end of the current financial year. It expects to have a net income of ₹ 25,000 and has a proposal for making new investments of ₹ 50,000. Show that under the MM assumptions, the payment of dividend does not affect the value of the firm.

(d)The value of the company can be maximized if the shareholders’ wealth is maximized. The par value of equity share of COMOS Limited is ₹ 100 per share. The company’s earning per share is ₹ 10. The return on retained earnings of the company is 15% and the rate of capitalization of the market is 10%.

The following are the alternates available before the management regarding the distribution of dividend :

(i)To have a pay-out ratio of 20%

(ii)To have a pay-out ratio of 40%

(iii)To have a pay-out ratio of 60%

(iv)To have a pay-out ratio of 0% or To have a retention of earning 100%.

You are required to calculate market price of the equity shares of the company in all above circumstances and suggest which alternative consider the best by using Walters’ Model.

Which among the following is not an assumption of Walter’s Model ?

(A)Firm’s Internal Rate of return and cost of equity capital are constant

(B)All earnings are either distributed or reinvested immediately

(C)All investments are financed through retained earnings

(D)The firm has a limited lifespan

Consider the following information : Rate of Return on Investment of a firm is 15%. Cost of Equity Capital is 12%. Earnings Per Share is ₹ 5 and Dividend Per Share is ₹ 3. The market value of the firm’s share as per Walter’s model will be ( ₹ ) :

(A)40.83

(B)50.28

(C)45.83

(D)42.85

Which of the following is/are assumption(s) of Walter’s Model of Equity Valuation?

(A)All the investments are routed through Retained Earnings only

(B)The firm’s Internal rate of Return and Cost of Capital are constant

(C)All earnings are either distributed as dividend or reinvested internally immediately

(D)All of the above

The formula for Walter’s Model of Equity Valuation is :

Which of the following is not correct explanation of abbreviations used in the formula ?

(A)P-Market Price per share

(B)D-Dividend per share

(C)r-Rate of Interest

(D)E-Earning per share

Which one of the following is not an assumption of Walter’s model ?

(A)The firm finance all investment through Debt or Retained earnings

(B)The firm’s internal rate of return is constant

(C)The firm’s cost of equity capital is constant

(D)The firm has a very long or infinite life

According to the Walter’s model, a firm should have 100% dividend pay-out ratio when :

(A)r = ke

(B)r < ke

(C)r > ke

(D)g > ke

The earning per share of a company is ₹ 10. It has an internal rate of return of 15% and the capitalization rate of the same risk class is 12.5%. If Walter’s model is used, what should be the price of a share at optimum payout ?

(A)92

(B)94

(C)96

(D)98

Walter model can be applied only to those companies which :

(A)Earn high profits.

(B)Make investment by resorting to high level of debts.

(C)Make investments without borrowing or raising external equity.

(D)Do not make any investment.

Determine the market price of a share of A Ltd. by using Gordon’s Model. Given k = 12%, E = 20, r = 12%, b = 60% e

(A)₹ 166.67

(B)₹ 210.52

(C)₹ 189.19

(D)₹ 181.82

Which of the following statement is correct with respect to Gordon’s model?

(A)When IRR is greater than cost of capital, the price per share increases and dividend pay-out decreases

(B)When IRR is greater than cost of capital, the price per share decreases and dividend pay-out increases

(C)When IRR is equal to cost of capital, the price per share increases and dividend pay-out decreases

(D)When IRR is lower than cost of capital, the price per share increases and dividend pay-out decreases

The cost of capital of a firm is 12% and its expected Earning Per Share at the end of the year is ₹ 20. Its existing payout ratio is 25%. The company is planning to increase its payout ratio to 50%. What will be the effect of this change on the market price of equity shares (MPS) of the company as per Gordon’s model, if the reinvestment rate of the company is 15% ?

(A)It will increase by ₹ 444

(B)It will decrease by ₹ 444

(C)It will increase by ₹ 222

(D)It will decrease by ₹ 222

AYou currently own 200 shares of stock in Baba Ltd. The stock currently trades at 240 per share. The company is contemplating a 1 : 2 stock split (two shares in place of every share held). Which of the following best describes your position after the proposed stock split takes place ?

(A)You will have 400 shares of stock, and the stock will trade at or near 240 per share

(B)You will have 200 shares of stock, and the stock will trade at or near ₹ 120 per share

(C)You will have 400 shares of stock, and the stock will trade at or near ₹ 120 per share

(D)You will have 100 shares of stock, and the stock will trade at or near ₹ 480 per share