Dividend Policy

Company's total net income can be divided into two parts: earnings to
be distributed to the equity shareholders and earning to be kept in the
organisation. Earnings that are distributed to the shareholders are
known as dividend and earnings that kept in the organisation are
known as retained earnings.
Dividend policy determines the division of earnings between payments
to stockholders and reinvestment in the firm. Retained earnings are
one of the most significant sources of funds for financing whereas
dividends constitute the cash flow that accumulates to stockholders.
DIVIDEND PAYMENT
The companies generally do not increase level of dividends to
shareholders unless it is sure that it can be maintained in the future as
well. A firms cash flows and investment needs are too volatile for it to
set a very high regular dividend. In such a case, the directors can set a
relatively low regular dividend, that it can be maintained even in low
profit years.
PAYMENT PROCEDURE
The normal dividend procedures are as follows:
Declaration Date: This the date of Board of Directors meeting when
regular dividend is declared. Example: If the directors meet say, on
January 10 and declare the regular dividend on this date, the date is
known as declaration date.
Holder-of-Record Date: If this date is not stated then there will be
confusion as to whether new or old shareholder should receive
dividend because shares keep on trading in the market. E.g. If the
Holder of record date is se as February 15, then we should understand
that it is a date of making a list of shareholders who are entitled to
receive dividends. On this date, the company closes its stock transfer
books and makes up a list of the shareholders as of that date. These
are the shareholders who are entitled to receive dividends.
Ex-dividend Date: In this case, ex-dividend date is four days prior to
February 15, or February 11. It means any sale or purchase of stock
should be informed to the company 4 days before holder of the record
date.
Payment Date: On this date, the company actually pays the dividends
or mails the cheques to the stockholders. If this date is set as March 1,
the payment will be made on this date.
STOCK DIVIDEND
Stock dividend is a form of dividend out of two forms: cash dividend
and stock dividend. In the stock dividend company distributes shares
as dividend to the shareholders and this dividend is distributed either
from past retained earnings or from net profit earned in the respective
year.
The share price of stock dividend is fixed at market price at the time of
dividend declaration. The declaration of stock dividend will increase the
additional paid in capital and reduce the retained earnings. Therefore,
it involves making a transfer from the retained earnings amount to the

other shareholder's equity account (common stock and additional paid

in capital).
Reasons of Stock Dividend

To increase share capital,

To provides tax benefit to the shareholders. Stock dividend is not

a taxable income but cash dividend is a taxable income,

To keep cash in the organisation. A company having less liquidity

pay stock dividend to conserve cash,

To decrease the share price at taxable range,

To provide psychological value of the shareholders.

STOCK SPLIT
Stock split is also a kind of stock dividend where company breaks
shares through splitting the par value of the share. Split takes place in
two ways viz. straight stock split and reverse stock split.
Straight Stock Split: In the straight split, company increases no. of
shares through a proportional reduction in the par value of stock.
Straight split takes place to bring the market price in reasonable range
and to increase the total dividend without increasing dividend per
share. Stock splits are similar to stock dividends. As a result of the
stock split, the common stock, additional paid in capital and retained
earnings remain unchanged. Shareholders' equity also stays the same;
the only change is in the par value of the stock.
Reverse Stock Split: In the reverse stock split, the company reduces
number of shares outstanding through merging the par values of the
stocks. This takes place to bring low priced shares up at desirable
trading levels. Reverse stock split is the opposite of straight stock split
where the par value increase but the common stock, retained earnings
and additional paid in capital remain unchanged.

1)

2)
3)
4)

Comparison between Stock Dividend & Stock Split

Stock Dividend
Stock Split
A stock dividend involves a 1) A stock split simply increases
book keeping transfer from
the
number
of
shares
the retained earnings to the
outstanding.
capital stock account. It is
paid in shares of stock
instead of cash.
A stock dividend increases 2) A stock split does not affect
the capital stock account.
the capital stock account.
A stock dividend does not 3) A stock split reduces the par
change in par value of stock.
value of the stock
A stock dividend reduces the 4) A stock split does not affect
retained earnings.
retained earnings.

STOCK REPURCHASE
Company repurchases its own stock as dividend decision. It is also
said that stock repurchase is an alternative of cash dividend. Under his
plan, company distributes cash to the shareholders buying back some
of its own outstanding stock, thereby decreasing the no. of shares,
which would increase earning per share and the stock price.

Reasons of Stock Repurchase: Co. repurchases its own stock due to

number of reasons like, to bring change in the existing capital
structure, to increase value of stocks in future, to distribute temporary
excess cash (liquidity) etc.

DIVIDEND PAYMENT SCHEMES

Constant Dividend per Share

Under this policy, dividend of fixed and constant per share is paid. This
policy may be stated as Rs 20 dividend per share' and so on. This
fixed amount of dividend per paid on an annual basis irrespective of
earnings for the year. More clearly, the earnings may fluctuate from
year to year but dividends per share generally remain stable. However
it does not mean that dividend per share remains fixed for the times to
come. Rather, the amount of dividend per share is likely to increase
over the years along with the increase in earnings and the firms try to
maintain the dividend stable at the new level.
Constant Payout Ratio
Payout ratio refers to the ratio of dividends per share to the earnings
per share. Under this policy a firm tries to maintain constant dividend
payout ratio over the years. For example if dividend pay out ratio is 60
percent, firm always pays 60 percent of its annual earnings as
dividend. Because of fixed payout ratio, dividends fluctuate. That is, if
earnings increase, dividend also increases proportionately and if
earning decreases, dividend also decreases in exact proportion. If the
firm suffers from loss in any year, the dividend even becomes low or
zero.
Low Regular Dividend plus Extra
The firm applying this policy determines a minimum constant dividend
plus some extra amount of dividend depending upon the earnings. The
minimum limit of dividend per share is fixed and additional dividend is
paid over the regular low dividends in the years of relatively high
earnings. As soon as the earning decline to normal level, the firm cuts
its extra dividend and pays only the normal or minimum dividend.
Residual Dividend Policy
Residual Dividend Policy suggests that a firm should retain its earnings
as long as it has investment opportunities that promise higher rate of
return than the investors required rate of return. Under Residual
Dividend Policy a firm pays dividend only after meeting its investment
need. In other words, dividends are paid out from the leftover earnings.

THE SIGNALING EXPLANATION

Companies that pay dividends seem to maintain a relatively stable
dividend, either in terms of a constant or growing dividend payout or in
terms of a constant or growing dividend per share. And when
companies change their dividendeither increasing or reducing
(cutting) the dividendthe price of the companys shares seems to
be affected: When a dividend is increased, the price of the companys
shares typically goes up; when a dividend is cut, the price usually goes
down. This reaction is attributed to investors perception of the

meaning of the dividend change: increases are good news, decreases

are bad news.
The board of directors is likely to have some information that investors
do not have; a change in dividend may be a way for the board to signal
this private information. Because most boards of directors are aware
that when dividends are lowered, the price of a share usually falls,
most investors do not expect boards to increase a dividend unless they
thought the company could maintain it into the future. Realizing this,
investors may view a dividend increase as the boards increased
confidence in the future operating performance of the firm.
FACTOR INFLUENCING DIVIDEND POLICY
Legal Rules: The legal rules provide that dividends must be paid from
earnings either from the current years earnings or from past years
earnings as reflected in the balance account retained earnings. If
there are no earnings, then dividends cannot be paid. In this situation,
normally three rules should be considered.
a. Net Profit Rule: It suggests that dividend can be paid from
earnings only.
b. Capital Impairment Rule: It states that dividend cannot be
paid from the capital. It protects creditors by stopping the
payment of dividend from capital.
c. Insolvency Rule: It states that dividends cannot be paid if the
company is insolvent. Insolvency is usually defined in the
bankruptcy sense. It is the situation where liabilities exceeding
assets.

Tax position of Stockholders: The dividend policy also depends

upon the tax position of the shareholders. If the firm is closely held by a
few shareholders in high income tax brackets, then it is likely to pay a
relatively low dividend. On the other hand, if the firm is very large and
its stocks are widely held, the firm might prefer a high dividend payout.

Questions
1.

Gurung Medicos stock trades at Rs. 90 a share. The

company is contemplating a 3 for 2 stock splits. Assuming
that the stock split will have no effect on the market value
off its equity, what will be the companys stock price
following the stock split? (Rs. 60)

2.

After a three-for-one stock split, NICE Company paid a

dividend of Rs. 4. This represents an 8% increase over
last year's pre-split dividend. NICE Company's stock sold
for Rs. 80 prior to the split. What was last year's dividend
per share? (Rs. 11.11)

3.

After a 5 for 1 stock split, the Lalitpur Finance Company

paid a dividend of Rs. 0.75 per new share, which
represents a 9% increase over last years pre-split
dividend. What was last years dividend per share? (Rs.
3.44)

4.

RAT Company stock earns Rs. 7 per share, sells for Rs.
30, and pays a Rs. 4 dividend per share. After a two-forone split, the dividend will be Rs. 2.70 per share. By what
percentage has the payout increased? (35%)

Rate of Asset Expansion: If the rate of asset expansion or growth is

high, the firm would retain more earnings into the business thus
following a conservative dividend policy. It is because the more rapidly
a firm grows, the greater would be its needs for financing asset
expansion. It pays out dividends in such cases; the firm is required to
raise funds externally.
Profit Rate: If profit rate is increasing the company, then the firm may
follow liberal dividend policy, other things remaining the same. On the
other hand, if profit rate is declining, the firm is forced to follow
conservative dividend policy.
Stability of Earnings: Along with the rate of profit, stability of profit is
also equally important. The firm can raise dividend payment only if
earnings are stable. The firms with stable earnings are likely to pay
higher dividends.
Control: If the shareholders are not willing to loose their control or
ownership the firm follows conservative dividend policy. It will try to rely
on internal financing if the profitable project emerges. It is because
raising funds by selling additional common stock dilutes the control of
the existing shareholders. Thus, reliance on internal financing in order
to maintain control reduces the dividend payment.
Dividend Policy/MBS_1st_Year

5.

The Wax Company's shareholders' equity account as of

December 31, 2009 is as follows:
Common Stock (Rs. 5 par value,
10,00,000 shares)
Rs. 50,00,000
Additional Paid in Capital
50,00,000
Retained Earnings
1,50,00,000
Total Shareholders' Equity
Rs. 2,50,00,000
Currently, Wax is under pressure from shareholders to pay
some dividends. Wax cash balance is Rs. 500,000, all of
which is needed for transactions purposes. The stock is
trading for Rs. 7 a share.
a. Reformulate the shareholders' equity account if the
company pays a 15% stock dividend.
b. Reformulate the shareholders' equity account if the
company declares a 5 for 4 stock splits.
c. Reformulate the shareholders' equity account if the
company declares a 4 for 1 reverse stock splits.

JT Company has 2.4 million shares of common stock

outstanding; the present market price per share is Rs. 36.
Its equity capitalization is as following
Common stock Rs. 2.00 par
Rs. 4,800,000
Additional paid-in capital
5,900,000
Retained earnings
87,300,000
Shareholders' equity Rs.98,000,000
a. What would happen to these accounts if the company
were to declare (1) a 12% stock dividend? (2) a 5%
stock dividend?
b. What would happen to the accounts if the company
declared (1) a 3-for-2 stock split? (2) a 2-for-1 stock
split? (3) a 3-for-1 split?
c. What would happen if there were a reverse stock split
of (1) 1-for-4? (2) 1-for-6?

Liquidity Position: the distribution of dividends depends on liquidity

position. If the liquidity position of the company is bad, it may not be
able to pay cash dividend.
Need to Repay Debt: If the firm has a need to repay the debt, it will
not be able pay higher dividend. If it pays dividend then it will not be
able to repay debt.

6.

7.

The Mohan Corporation declared a 6% stock dividend.

Construct a pro forma balance sheet showing the effect of
this action. The stock was selling for Rs. 37.50 per share,
and a condensed version of Mohans balance sheet as of
December 31, 1995 before the dividend follows (millions of
Rupees):
Cash
Rs. 112.5 Debt
Rs. 1,500
Other
Rs. Common Stock (75
Rs. 75
assets
2,887.5 million shares, Rs.
1 par)
Paid in Capital
Rs. 300
Retained Earnings
Rs. 1,125
Total
Total Liabilities and
Rs. 3,000
Rs. 3000
Assets
Equity

8.

A firm has issued 120,000 equity shares of Rs. 10 each,

has a premium account of Rs. 20,00,000 and retained
earnings of Rs. 30,00,000. The market value of equity
share is Rs. 30. Prepare the shareholders equity section
of BS after the stock split. What will be the face value and
estimated price per share just after the split? The firm
declared a 2 for 1 stock split.

9.

A firm has 500,000 outstanding shares of Rs. 2 par

common stock, a contributed capital in excess of par
account of Rs. 8.4 million and the retained earnings of Rs.
32 million, all before the declaration of dividends. The
board of directors declared a Rs. 3 per share cash
dividend. What are the balances in the equity accounts if
the market value of the stock is Rs. 35 per share? What
will be the market price after cash dividend?

10. SPM Company has outstanding shares of 20,00,000 with

a par value per share of Rs. 4 each. The premium
Page 2 of 5

recorded Rs. 64,00,000 and the retained earning

amounting to Rs. 2,32,00,000. The BODs declared Rs.
0.50 as cash dividend per share and 25% as stock
dividend. The market value per share is raised to Rs. 10.
Find out the effects of change in Equity, Premium and
Retained Earnings.
11. Ram & Sons has 20,00,000 outstanding share of Rs. 2
par common stock, a contributed capital in excess of par
account of Rs. 32,00,000 and retained earning of Rs.
160,00,000, all of before the declaration of dividends. The
BODs declared a Rs. 1.50 per share cash dividend and a
25% stock dividend. What are the balances in the equity
accounts if the fair market value of the stock is Rs. 25 per
share?
12. The Mohani Corporation declared a 6% stock dividend
plus a cash dividend of Rs. 0.90 per share. The cash
dividend was paid on both the old shares and the new
shares received from the stock dividend. Construct a pro
forma balance sheet showing the effect of this action. The
stock was selling for Rs. 37.50 per share, and a
condensed version of Mohanis balance sheet as of
December 31, 2010 before the dividend follows (millions of
Rupees):
Cash
Rs. 112.5 Debt
Rs. 1,500
Other
Rs. Common Stock (90
assets
2,887.5 million authorized,
75 million shares,
Rs. 1 par)
Rs. 75
Paid in Capital
Rs. 300
Retained Earnings
Rs. 1,125
Total
Total Liabilities and
Rs. 3,000
Rs. 3000
Assets
Equity
13. Zeta Manufacturers shareholders' equity, December 30,
1991:
Common stock (Rs.100 par, 300,000
Rs. 30,000,000
shares)
Additional paid-in capital
15,000,000
Retained earnings
55,000,000
Shareholders' equity
Rs. 100,000,000
On December 31, Zeta split the stock 2-for-1 and then
declared a 10% stock dividend. The price of the stock on
December 30 was Rs. 500. Reformulate the stockholders'
capitalization accounts of the firm.
14. The King Company has the following shareholders' equity
account:
Common stock (Rs. 8 par value)
Rs. 2,000,000
Additional paid-in capital
1,600,000
Dividend Policy/MBS_1st_Year

Retained earnings
8,400,000
Shareholders' equity Rs. 12,000,000
The current market price of the stock is Rs. 60 per share.
a. What will happen to this account and to the number of
shares outstanding with (1) a 20% "small-percentage"
stock dividend? (2) a 2-for-1 stock split (3) a 1-for-2
reverse stock split?
b. (1) In the absence of an informational or signaling
effect, at what share price should the common stock
sell after the 20% stock dividend? (2) What might
happen if there were a signaling effect?
15. The S Co. capital structure on December 30, 1990:
Common Stock (Rs. 1 par, 10,00,000
Rs.
shares)
10,00,000
Paid in Capital
3,00,000
Retained Earnings
17,00,000
Rs.
Net Worth
30,00,000
The firm earned Rs. 3,00,000 after taxes in 1991 and paid
out 50% of these earnings of dividends. The price of the
firms stock on Dec. 30 was Rs. 5.
a. If the firm declared a stock dividend of 3% on Dec. 31,
what would be the reformulated capital structure?
b. Assuming the firm paid no stock dividend, what would
be the earning per share for 1991? Dividend per
share?
c. Assuming a 3% stock dividend, what would happen to
EPS and DPS for 1991?
d. What would be the price of the stock after 3% stock
dividend, if there were no signaling or other effects?
16. Bijay Company has 500,000 shares of common stock
outstanding. Its capital stock account is Rs. 500,000, and
retained earnings are Rs. 2 million. Bijay is currently
selling for Rs. 10 per share and has declared a 10% stock
dividend. After distribution of the stock dividend, what
balances will the retained earnings and capital stock
accounts now? (Rs. 15,00,000, Rs. 10,00,000)
17. The Canales Copper Company declared a 25% stock
dividend on March 1 to stockholders of record on April 1.
The market price of the stock is Rs. 50 per share. You
own 160 shares of the stock.
a. If you sold your stock on March 20, what would be the
price per share, all other things the same? (No
signaling effect.)
b. After the stock dividend is paid, how many shares of
stock will you own?

c.

d.
e.

At what price would you expect the stock to sell on

April 2, all other things the same? (No signaling
effect.)
What will be the total value of your holdings before
and after the stock dividend all other things the same?
If there were an informational or signaling effect, what
would be the effect on share price?

18. In 2000 the Odom Company paid dividends totaling Rs.

1,125,000. For the past ten years, earnings have grown at
a constant rate of 10%. After-tax income was Rs.
3,750,000 for 2000. However, in 2001, earnings were Rs.
6,750,000 with investment of Rs. 5,000,000. It is predicted
that Odom Company will not be able to maintain this
higher level of earnings and will return its previous 10%
growth rate. Calculate dividends for 2001 if Odom
Company follows each of the following policies.
a. Its dividend payment is stable and growing. (Rs.
11,25,000, Rs. 12,37,500)
b. It continues the 2000 dividend payout ratio. (Rs.
20,25,000)
c. It uses a pure residual dividend policy (30% of the Rs.
5,000,000 investment was financed with debt.) (Rs.
32,50,000)
d. The investment in 2001 is financed 90% with retained
earnings and 10% with debt. Any earnings not
invested are paid out as dividends. (Rs. 22,50,000)
e. The investment in 2001 is financed 30% with external
equity, 30% with debt and 40% with retained
earnings. Any earnings not invested are paid out as
dividends. (Rs. 47,50,000)
19. The Beta-Alpha Company expects with some degree of
certainty to generate the following net income and to have
the following capital expenditure during the next 5 years
(in thousands):
Year
1
2
3
4
5
Net Income Rs.2,000

Rs.1,50 Rs.2,50 Rs.2,30 Rs.1,80

0
0
0
0

Capital
Rs.
Rs.
Rs.
Rs.
Rs.
Expenditure
1,000 1,500 2,000 1,500 2,000
s
The company currently has 1 million shares of common stock
outstanding and pays dividends of Re. 1 per share.
a. Determine DPS and external financing required in
each year if dividend policy is treated as a residual
decision.
Page 3 of 5

b.

c.

d.

Determine the amounts of external financing in each

year that will be necessary if the present DPS is
maintained.
Determine DPS and the amounts of external financing
that will be necessary if a dividend-payout ratio of
50% is maintained.
Under which of the three dividend policies are
i) Aggregate dividends maximized?
ii) External financing minimized?

20. The Gaurav Company expects next years net income to

be Rs. 15 million. The firms debt ratio is currently 40%,
Gaurav has Rs. 12 million of profitable investment
opportunities and it wishes to maintain its existing debt
ratio. According to the residual dividend policy, how large
should Gauravs dividend payout ratio be next year?
(52%)
21. ABC Telecom has a target capital structure that consists
of 70% debt and 30% equity. The Company anticipates
that its capital budget for the upcoming year will be Rs.
30,00,000. If ABC reports net income of Rs. 20,00,000
and it follows a residual dividend payout policy, what will
be its dividend payout ratio? (55%)
22. Pixel Company has a capital budget of Rs. 1.2 million. The
company wants to maintain a target capital structure that
is 60% debt and 40% equity. The company forecasts that
its net income this year will be Rs. 6,00,000. If the
company follows a residual dividend policy, what will be its
payout ratio? (20%)
23. Modern Cable TV Inc. has a target capital structure that
consists of 60% debt and 40% equity. The company
anticipates that its capital budget for the upcoming year
will be Rs. 3,000,000. If company reports net income of
Rs. 2,000,000 and it follows a residual dividend payout
policy, i) what will be its dividend payout ratio? And ii) if
retained earnings is reinvested at internal rate of return of
20%, what is the anticipated growth rate in earnings?
(40%, 12%)
24. The Butwal Trading Corporation has Rs. 2 million of
backlogged orders for its patented solar hearing system.
Management plans to expand production capacity by 30%
with a Rs. 6 million investment in plant and machinery.
The firm wants to maintain a 45% debt-to-total asset ratio
in its capital structure; it also wants to maintain its past
dividend policy of distributing 20% of after tax earnings. In
2005 earnings were Rs. 2.6 million. How much external
Dividend Policy/MBS_1st_Year

equity must the firm seek at the beginning of 2006. (Rs.

1.22 Million)
25. A firm's net income for next year is Rs. 2 million, the
company's target and current capital structure is 40%
debt and 60% equity. Currently, the company has
500,000 shares outstanding. The par value per share
is Rs. 100. The optimal capital budget for next year is
Rs. 400,000.
a. Determine the total dividend and retained
earnings, if any, next year if company uses
constant dividend of Rs. 2 per share.
b. Determine the total dividend and retained
earnings, if any, next year if company uses
constant payout of 80%.
c. Calculate
the
external
equity
financing
requirement for 'a' and 'b' above if the optimal
capital budget for next year is Rs. 15,00,000.
26. Lalitpur Textile Company expects next years after tax
income to be Rs. 5 million. The firms current debt equity
ratio is 80%. If the company has Rs. 4 million of profitable
investment opportunities and wishes to maintain its current
debt equity ratio, how much should it pay out in dividends
next year? (Rs. 27,77,778)
27. ABC Mill has a current and target capital structure of 30%
debt and 70% equity. Last year ABC used a residual
dividend policy, had a dividend payout ratio of 47.5% and
net income of Rs. 8,00,000. What was ABC's capital
budget? (Rs. 600,000)
28. National Music Companys earnings per share over the
last 10 years were the following:
Year
1
2
3
4
5
EPS (Rs.)
1.70
1.82
1.44
1.88
2.18
Year
6
7
8
9
10
EPS (Rs.)
2.32
1.84
2.23
2.50
2.73
Determine annual DPS under the following policies.
a. A constant dividend pays out ratio of 40%.
b. A regular dividend of Rs. 0.80 and an extra dividend
to bring the payout ratio to 40% if it otherwise would
fall below.
29. Malakar Instruments Company treats dividends as a
residual decision. It expects to generate Rs. 2 million in
net earnings after taxes in the coming year. The company
has all-equity capital structure and its cost of equity capital
is 15%. The company treats this cost as the opportunity
cost of retained earnings. Because of flotation costs and

underpricing, the cost of common stock financing is

higher. It is 16%.
a. How much in dividends (out of the Rs. 2 million in
earnings) should be paid if the company has Rs. 1.5
million in projects whose expected return exceeds
15%?
b. How much in dividends should be paid if it has Rs. 2
million in projects whose expected return exceeds
15%?
c. How much in dividends should be paid if it has Rs. 3
million in projects whose expected return exceeds
16%? What else should be done?
30. Babu Industries has earnings this year of Rs. 16.5 million,
50% of which is required to take advantage of the firm's
excellent investment opportunities. The firm has 206,250
shares outstanding, selling currently at Rs. 320 a share.
Ramesh Thapa, a major stockholder (18,750 shares), has
expressed displeasure with a great deal of managerial
policy. Management has approached him with the
prospect of selling his holdings back to the firm, and he
has expressed a willingness to do at a price of Rs. 320 a
share. Assuming that the market uses a constant PE ratio
of 4 in valuing the stock, answer the following questions.
a. Should the firm buy Thapa's shares? Assume that
dividends will not be paid on them if they are
repurchased. (Buy)
b. How large a cash dividend should be declared? (Rs.
12)
c. What is the final value of Babu Industries' stock after
all cash payment shareholders? (Rs. 352)
31. XYZ Corporation has enjoyed considerable recent
success because Brazil placed a huge order for potatoes.
The business is not expected to be repeated, and XYZ
has Rs. 6 million in excess funds. The company wishes to
distribute these funds via the repurchase of stock.
Presently, it has 2,400,000 shares outstanding, and the
market price per share is Rs. 25. It wishes to repurchase
10% of its stocks, or 240,000 shares.
a. Assuming no signaling effect, at what share price
should the company offer to repurchase? (Rs. 27.78)
b. In total, how much will the company be distributing
through share repurchase. (Rs. 66,67,200)
c. If the company were to pay out the funds through
cash dividends instead, what would be the market
price per share after the distribution? (Rs. 22.22)
d. Why does the company repurchase its own stocks?
32. Birat Company has 100,000 shares outstanding, the par
value per share is Rs. 100 and each share is currently
selling for Rs. 500. The company earned Rs. 750,000
Page 4 of 5

profit this year. The company has investment opportunity

of Rs. 10,00,000 that provides return greater than the cost
of capital. The company maintains 50% debt ratio.
a. What amount of earning will company distributes as
dividend if the company follows residual dividend
policy? What will be the dividend payout ratio?
b. Instead of paying cash dividend, if the company pays
10% stock dividends, what will happen in the par
value, market value and number stocks of the
company?
c. If the company doesnot pay cash or stock dividend
but repurchases 1000 shares from market, what is the
equilibrium repurchase price of stock?
33. ABC Corporation makes musical instruments and
experiences only moderate growth. The company has just
paid a dividend and is contemplating a dividend of Rs.
1.35 per share 1 year hence. The present market price per
share is Rs. 15 and stock price appreciation of 5% per
annum is expected.
a. (1) If the required return on equity were 14% and we
lived in a no-tax world, what would be the market
price per share at the end of the year using the MillerModigliani model? (2) What would be the price if no
dividend were paid? (Rs. 15.75, Rs. 17.10)
b. Jeewan, a stockholder, in a 30% tax bracket for
ordinary income, but his effective tax rate for capital
gains 20%. If he were to hold the stock 1 year, what
would be his expected after-tax return in rupees for
each share held? (Rs. 1.55)

dividend policies are dramatically different. Firm A retains

80% of its net income for future investment and its
dividends grow (forever) at 8% per year (g = .08). Firm B
retains only 20% of its net income and its dividends grow
at 4% per year (g = 0.04). Which firm is worth more? (Rs.
6480, Rs. 8320, B)
36. Beta Industries has net income of Rs. 20,00,000 and it has
10,00,000 share of common stock outstanding. The
companys stock currently trades at Rs. 32 a share. Beta
is considering a plan in which it will use available cash to
repurchase 20% of its shares in the open market. The
repurchase is expected to have no effect on either net
income or the companys P/E ratio. What will be its stock
price after the stock repurchase? (Rs. 40)

34. Man Company belongs to a risk class for which the

appropriate required equity return is 15%. It currently has
outstanding 100,000 shares selling at Rs. 100 each. The
firm is contemplating the declaration of a Rs. 5 dividend at
the end of the current fiscal year, which just began.
Answer the following questions based on the Modigliani
and Miller Model and the assumption of no taxes.
a. (1) What will be the price of the stock at the end of the
year if a dividend is not declared? (2) What will it be if
one is?
b. Assuming that the firm pays the dividend, has net
income of Rs. 1 million, and makes new investments
of Rs. 2 million during the period, how many new
shares must be issued?
c. Is the MM model realistic with respect to valuation?
What factors might mar its validity?
35. Firm A and B carry no debt, have the same current
earnings before interest and taxes (EBIT=Rs. 1,000) the
same tax rate (T = 40%), and the same unlevered cost of
capital (Ku = 10%). However, their growth rates and
Dividend Policy/MBS_1st_Year

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