Question 4 OR (b)
Walter model: DPS for a target price, optimum payout and analysis
12 marks
- Time to write
- About 24 minutes
Question
Question 4 OR (b) · 12 marksThe Following information has been taken from the annual report of Tarun Ltd.
Earnings of the firm Rs. 9,60,000
No. of Equity Shares 2,40,000
Return on Investment 15%
Cost of Equity 10%
Using the Walter Model, what would the dividend per share be if we want to keep the share price at Rs. 45? Also compute the Dividend payout ratio?
What will the optimal dividend payout ratio be, and the Market price at the optimal dividend payout ratio.
What will the Market price be at a 100% dividend payout ratio. Also analyse how a change in the Dividend payout ratio affects market the price of shares in the above question.
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
- What…?Compute…?Analyse…3 asks, each with its own marks below. Answer all 3.
- computeFormula first, then the working, then the answer with its unit (₹, %, units).
What the paper leaves open
"Market the price of shares" is printed so and kept.
Write it in this order
- Read the data; note exactly what is asked 2 min
- 1 (i) DPS and payout for a price 4 marks 7 min
- 2 (ii) Optimal payout and price 4 marks 7 min
- 3 (iii) Price at 100% payout and analysis 4 marks 6 min
- Check: arithmetic, units (₹, %), final answer underlined 2 min
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.
EPS = ₹9,60,000 ÷ 2,40,000 = ₹4; r = 15%; ke = 10%; r ÷ ke = 1.5. Walter's formula: P = [D + (r ÷ ke)(E − D)] ÷ ke.
(i) DPS for a price of ₹45: 45 = [D + 1.5(4 − D)] ÷ 0.10, so 4.5 = D + 6 − 1.5D, so 0.5D = 1.5 and DPS = ₹3. Payout ratio = 3 ÷ 4 = 75%. Check: [3 + 1.5 × 1] ÷ 0.10 = ₹45.
(ii) Optimal payout and price. Since r (15%) > ke (10%), the firm is a growth firm and the optimal payout ratio is 0%. Price at nil payout: [0 + 1.5 × 4] ÷ 0.10 = ₹60.
(iii) Price at 100% payout: [4 + 0] ÷ 0.10 = ₹40.
| Payout | DPS (₹) | Price (₹) |
|---|---|---|
| 0% | 0 | 60 |
| 75% | 3 | 45 |
| 100% | 4 | 40 |
Every increase in the payout ratio lowers the share price, because each rupee retained earns 15% inside the firm against the 10% shareholders require. For a growth firm (r > ke), the price is highest when all earnings are retained and lowest when all are paid out.
Where the 12 marks sit
| # | Component | Marks |
|---|---|---|
| 1 | (i) DPS and payout for a ₹45 price | 4 |
| 2 | (ii) Optimal payout and price | 4 |
| 3 | (iii) Price at 100% payout and analysis | 4 |
| Total | 12 |
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