Question 4 OR (b)
Gordon's model: share price
8 marks
- Time to write
- About 16 minutes
From an older CBCS paper
Question
Question 4 OR (b) · 8 marksA company's total investment in assets is Rs. 600,000, and it has 60000 ordinary shares ofRs10 each outstanding. It earns 15% on its investment, and its policy is to retain 50% of the earnings. If the firm's appropriate discount rate is 10%, determine its share price using Gordon's model. 8
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
Read from the question
- determineFormula first, then the working, then the answer with its unit (₹, %, units).
What the paper leaves open
Earnings per share are the return on investment per share: the investment over the number of shares, times 15%. "ofRs10" is kept as printed.
Write it in this order
- Read the data; note exactly what is asked 1 min
- 1 Gordon's formula and assumptions 2 marks 4 min
- 2 EPS and growth rate 3 marks 5 min
- 3 Share price 3 marks 5 min
- Check: arithmetic, units (₹, %), final answer underlined 1 min
Try it first. About 16 minutes for 8 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.
Gordon's model. P = E(1 − b) ÷ (ke − br), where E is earnings per share, b the retention ratio and r the rate of return; g = br. The model requires ke > br.
1Sunita holds this year's dividend—money in her hand today.
Current dividendsInvestors put a premium on certain returns.
2Verma ji's payout sits inside a half-built project, and he worries.
Retained earningsUncertain future gains.
3At the counter, savers crowd the company that pays now over the one that promises later.
Bird in handInvestors are risk averse and value current dividends more than uncertain future gains.
- Investment per share = 6,00,000 ÷ 60,000 = ₹10; EPS = 15% × 10 = ₹1.50 (paper note).
- b = 50%; g = 0.50 × 15% = 7.5%; ke = 10% (> 7.5%).
P = 1.50 × (1 − 0.50) ÷ (0.10 − 0.075) = 0.75 ÷ 0.025 = ₹30.
Where the 8 marks sit
| # | Component | Marks |
|---|---|---|
| 1 | Gordon's formula and assumptions | 2 |
| 2 | EPS and growth rate | 3 |
| 3 | Share price | 3 |
| Total | 8 |
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