Question 5 (a)
Walter's model for three firms at three payout ratios
8 marks
- Time to write
- About 16 minutes
From an older CBCS paper
Question
Question 5 (a) · 8 marksDetails of P Ltd, Q Ltd and S Ltd are below:
| P Ltd | Q Ltd | S Ltd |
|---|---|---|
| r = 15% | r =5% | R = 12% |
| Ke = 12% | Ke=12% | Ke = 12% |
| E = ₹8 | E=₹.8 | E = ₹ 8 |
Applying Walter's formula, calculate, for each of these companies, the value of an equity share at a dividend payout ratio of (a) 25% (b) 50% (c) 75%. What would you conclude?
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
- calculateFormula first, then the working, then the answer with its unit (₹, %, units).
What the paper leaves open
"E=₹.8" for the second company is read as ₹8, as for the others; it is kept as printed. "R = 12%" is read as r.
Write it in this order
- Read the data; note exactly what is asked 1 min
- 1 Formula and dividends 1 mark 2 min
- 2 Prices for the three firms at three payouts 5 marks 10 min
- 3 Conclusion 2 marks 2 min
- Check: arithmetic, units (₹, %), final answer underlined 1 min
Short on time? End with step 3's one-line conclusion, whatever happens: never leave the figures without it.
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.
Walter's formula: P = [D + r(E − D) ÷ ke] ÷ ke. E = ₹8 for each firm (paper note: "₹.8" read as ₹8); ke = 12%; dividends at 25%, 50% and 75% payout are ₹2, ₹4 and ₹6.
| Payout | D (₹) | P Ltd. (r = 15%) | Q Ltd. (r = 5%) | S Ltd. (r = 12%) |
|---|---|---|---|---|
| 25% | 2 | 79.17 | 37.50 | 66.67 |
| 50% | 4 | 75.00 | 47.22 | 66.67 |
| 75% | 6 | 70.83 | 56.94 | 66.67 |
Workings at 25% payout:
- P Ltd.: [2 + 0.15 × 6 ÷ 0.12] ÷ 0.12 = (2 + 7.50) ÷ 0.12 = ₹79.17.
- Q Ltd.: [2 + 0.05 × 6 ÷ 0.12] ÷ 0.12 = (2 + 2.50) ÷ 0.12 = ₹37.50.
- S Ltd.: [2 + 0.12 × 6 ÷ 0.12] ÷ 0.12 = (2 + 6) ÷ 0.12 = ₹66.67.
- P Ltd. (r > ke), a growth firm: the price falls as the payout rises; it should retain all its earnings (optimum payout 0%).
- Q Ltd. (r < ke), a declining firm: the price rises with the payout; it should distribute all its earnings (optimum payout 100%).
- S Ltd. (r = ke), a normal firm: the price is ₹66.67 whatever the payout; dividend policy is irrelevant.
Where the 8 marks sit
| # | Component | Marks |
|---|---|---|
| 1 | Formula and dividends | 1 |
| 2 | Prices for the three firms at three payouts | 5 |
| 3 | Conclusion | 2 |
| Total | 8 |
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