Question 4 OR (a)

Walter model: share price at three payouts and three rates of return

12 marks

Time to write: About 24 minutes
Topic: Dividend theories and dividend policy

Question

Question 4 OR (a) · 12 marks

The earning per share of Kabir Limited is ₹10. Using the Walter Model, calculate the price of a share if the DPS (i.e. dividend per share) is ₹0, 5, and 10. What should the dividend policy of the company be if its rate of return (r) is 8%, 10%, and 15% and the cost of equity (k_e) is 10%.

Reworded from the university paper: names and figures differ, the task is the same. The original paper belongs to the University of Delhi. See DU's question bank.

Before you write

Read off the question and its marks

24 minfor 12 marks

Read from the question

calculateFormula first, then the working, then the answer with its unit (₹, %, units).
should theEnd with a one-line decision that follows from your figures.

Write it in this order

Read the data; note exactly what is asked 2 min
1 Walter's formula 1 mark 2 min
2 Prices at the three payouts for each rate of return 6 marks 10 min
3 Dividend policy for each rate of return 5 marks 8 min
Check: arithmetic, units (₹, %), final answer underlined 2 min

123

Short on time? Step 2 carries 6 of the 12 marks: guard its minutes.

Try it first. About 24 minutes for 12 marks. Write it out, then open the solution.

Solution

Hover or tap a marked figure, like 72,000, to see how it is made and where else it appears.

Walter's formula: P = [D + (r ÷ ke)(E − D)] ÷ ke, with E = ₹10 and ke = 10%.

Price per share (₹)

DPS (₹)	r = 8%	r = 10%	r = 15%
0	(0 + 0.8 × 10) ÷ 0.10 = 80	(0 + 1 × 10) ÷ 0.10 = 100	(0 + 1.5 × 10) ÷ 0.10 = 150
5	(5 + 0.8 × 5) ÷ 0.10 = 90	(5 + 1 × 5) ÷ 0.10 = 100	(5 + 1.5 × 5) ÷ 0.10 = 125
10	(10 + 0) ÷ 0.10 = 100	(10 + 0) ÷ 0.10 = 100	(10 + 0) ÷ 0.10 = 100

Dividend policy

r = 15% (r > ke, a growth firm): the price is highest (₹150) when nothing is paid. The firm earns more on retained funds than shareholders require, so it should retain all its earnings (0% payout).
r = 10% (r = ke, a normal firm): the price is ₹100 at every payout. Dividend policy does not affect the value of the share; there is no optimum payout.
r = 8% (r < ke, a declining firm): the price is highest (₹100) when all earnings are paid out. Shareholders can earn more elsewhere, so the firm should distribute all its earnings (100% payout).

Where the 12 marks sit

#	Component	Marks
1	Walter's formula	1
2	Prices at the three payouts for each rate of return	6
3	Dividend policy for each rate of return	5
	Total	12

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