Question 4 OR (b)
MM dividend model: prices and new shares
8 marks
- Time to write
- About 16 minutes
From an older CBCS paper
Question
Question 4 OR (b) · 8 marksMeena Ltd.'s capital is ₹12,00,000, in equity shares of ₹ 100 each, currently quote at par. It proposes to declare a dividend of ₹ 10 per share at the close of the current financial year. The capitalization rate for its risk class is 12%. What will the share's market price be at the year's end, if ":
no dividend is declared,
the dividend is declared.
If the company pays the dividend, has net profits of ₹ 12,00,000 and makes new investment of ₹ 24,00,000 in the period, how many new shares must be issued ? Use the model of MM. 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
- how manyFormula first, then the working, then the answer with its unit (₹, %, units).
What the paper leaves open
"Currently quote at par" and the stray quotation mark are kept as printed.
Write it in this order
- Read the data; note exactly what is asked 1 min
- 1 Price with no dividend 2 marks 4 min
- 2 Price with the dividend 2 marks 3 min
- 3 New shares to be issued 3 marks 5 min
- 4 Check 1 mark 2 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.
MM model. P0 = (D1 + P1) ÷ (1 + ke), so P1 = P0(1 + ke) − D1; the number of new shares needed is m = [I − (E − nD1)] ÷ P1. Shares outstanding n = 12,00,000 ÷ 100 = 12,000; P0 = ₹100 (quoted at par); ke = 12%.
(i) No dividend declared: P1 = 100 × 1.12 − 0 = ₹112.
(ii) Dividend of ₹10 declared: P1 = 112 − 10 = ₹102.
(iii) New shares when the dividend is paid
| Particulars | ₹ |
|---|---|
| Net profit (E) | 12,00,000 |
| Less: dividend paid (12,000 × ₹10) | 1,20,000 |
| Retained earnings available | 10,80,000 |
| Add: funds to be raised by new shares (balancing figure) | 13,20,000 |
| New investment (I) | 24,00,000 |
m = 13,20,000 ÷ 102 = 12,941.18, so about 12,942 new shares must be issued.
Check (irrelevance). Value of the firm now = [(n + m)P1 − I + E] ÷ (1 + ke) = [(12,000 + 12,941.18) × 102 − 24,00,000 + 12,00,000] ÷ 1.12 = ₹12,00,000, the same as with no dividend.
Where the 8 marks sit
| # | Component | Marks |
|---|---|---|
| 1 | Price with no dividend | 2 |
| 2 | Price with the dividend | 2 |
| 3 | New shares to be issued | 3 |
| 4 | Check | 1 |
| Total | 8 |
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