Question 4 (a)

MM: price, new shares and total market value of Medilife Pharma

9 marks

Time to write: About 18 minutes
Topic: Dividend theories and dividend policy

Question

Question 4 (a) · 9 marks

Medilife Pharma Ltd currently has outstanding 1.2 lakh equity shares, Current market price per share is ₹20. The current year's net income is ₹2.4 Lakhs, and the investment budget is also ₹2.4 Lakhs. The cost of equity is 15%. The company is considering declaring a dividend @ ₹1 per share. Assuming MM Approach:

Calculate the market price per share of dividend is declared, and also if it is not declared.
Under both options, how many new equity shares are to be issued?
Show that the dividend decision leaves the total market value of shares unaffected.

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

18 minfor 9 marks

Read from the question

Calculate…How…?Show…3 asks, each with its own marks below. Answer all 3.
Show thatThe result is given: the marks are for the steps that reach it.
Assuming MM ApproachThe paper fixes this: use it as given, and say so in your answer.
CalculateFormula first, then the working, then the answer with its unit (₹, %, units).

What the paper leaves open

"Market price per share of dividend is declared" is read as "if dividend is declared".

Write it in this order

Read the data; note exactly what is asked 1 min
1 (i) Price with and without the dividend 3 marks 5 min
2 (ii) New shares in both options 3 marks 5 min
3 (iii) Total market value in both options 3 marks 5 min
Check: arithmetic, units (₹, %), final answer underlined 2 min

123

Try it first. About 18 minutes for 9 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 formulas: P1 = P0(1 + ke) − D1; m = [I − (E − nD1)] ÷ P1; nP0 = [(n + m)P1 − (I − E)] ÷ (1 + ke).

Here n = 1,20,000 shares, P0 = ₹20, ke = 15%, D1 = ₹1, E = ₹2,40,000 and I = ₹2,40,000.

(i) Market price at the end of the year

Dividend declared: P1 = 20 × 1.15 − 1 = ₹22.
Dividend not declared: P1 = 20 × 1.15 − 0 = ₹23.

(ii) New equity shares to be issued

Dividend not declared: the investment of ₹2,40,000 is met entirely from the year's net income of ₹2,40,000, so no new shares are needed (m = 0).
Dividend declared: dividend 1,20,000 × ₹1 = ₹1,20,000 is paid, leaving ₹1,20,000 of net income for investment.

₹	Dividend declared
Net income available (E)	2,40,000
New equity to be raised	1,20,000
Funds needed: investment + dividend (I + nD1)	3,60,000
Price per new share (P1)	22
Number of new shares (m)	5,454.55

(iii) Total market value of the shares

Dividend not declared: [1,20,000 × 23 − (2,40,000 − 2,40,000)] ÷ 1.15 = 27,60,000 ÷ 1.15 = ₹24,00,000.
Dividend declared: [(1,20,000 + 5,454.55) × 22 − 0] ÷ 1.15 = 27,60,000 ÷ 1.15 = ₹24,00,000.

The total market value is ₹24,00,000 (= 1,20,000 × ₹20) either way: the dividend is offset by the lower year-end price and the new shares issued, so the dividend decision leaves the total market value of the shares unaffected.

Where the 9 marks sit

#	Component	Marks
1	(i) Price with and without the dividend	3
2	(ii) New shares in both options	3
3	(iii) Total market value in both options	3
	Total	9

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