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Solutions of Tests of
April 2015 Batch
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Solution of Test of
Dividend Policy & Models
[SFM – CA Final]
Conducted on 8th August 2015
[Solution is at the end with marking for self-assessment]
Time Allowed-1 hour
Q1
Maximum Marks- 30
Consider following information:
Expected EPS
D / P Ratio
IRR
Ke
Multiplier
Current MPS
Rs.30
40%
15%
12%
5
250
Determine value per share as per –
(i) Graham and Dodd Model
(ii) Walter’s Model
(iii) Gordon’s Model
(iv) MM’s Model
Q2
(10 Marks)
For a firm current earnings per share is Rs.2 and last dividend paid is Re.0.4. For the
next five years the firm is expected to grow at a high rate of 24% during which its
retention ratio shall be 80% and its equity beta shall be 1.5.
Thereafter, there shall be an intermediate transition period of five years during which
the dividend payout ratio shall increase from 20% at the end of 5th year to 70% at the
end of 10th year by way of linear increments each year. There shall be no change in
the cost of equity and the growth rate of the firm shall be 20% in year 6, 16% in year
7, 12% in year 8, 8% in year 9 and 6% in year 10.
From the end of 10th year till perpetuity the firm shall grow at the rate of 4%, its
dividend payout ratio shall be 70% and its equity beta shall settle at 1. The risk free
rate of return is 7.5% and the market risk premium is 5.5%.
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Applying Capital Asset Pricing Model (CAPM), find the price of share as on today as
per the Gordon’s Dividend Model. A client of yours is interested in buying this share
which currently trades at Rs.35. What shall be your advice?
(10 Marks)
Q3
VascoDa Ltd. has 10 lakh equity shares of Rs.50 each. EAT is Rs.150 lakhs of
which Rs.50 lakhs was distributed as dividend. Current PE ratio of the company is
12. The company is evaluating new project costing Rs.378 lakhs and which is
expected to produce additional after tax earnings over a foreseeable future at the
rate of 15% of the amount invested. It is proposed by the CFO that money shall be
raised by a rights issue to existing shareholders at a price 30% below current MPS.
Compute:
i.
ii.
iii.
iv.
v.
Current MPS
Subscription price of Rights
Total number of right shares to be issued and rights ratio
Ex-rights Price on the basis of projected synergy
Determine the impact on wealth of a shareholder who holds 3,000 shares if rights are
subscribed or rights are sold
(10 Marks)
(Assessed answer papers shall be returned latest by 22nd August 2015)
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Solution of
Test of Dividend Policy & Models
Conducted on 8th August 2015
Q1
Expected DPS = 30 X 40% = Rs.12
Retention Ratio = 60%
Growth rate of Dividend = 60 X 15% = 9 %
(2 Marks)
(i) Graham and Dodd Model:
P0 = 5 [12 + 30 / 3] = Rs.110
(2 Marks)
(ii) Walter’s Model:
Vc = [12 + 15%/12% (30 – 12)]/12% = Rs.287.5
(2 Marks)
(iii) Gordon’s Model:
P0 = 12 / 12% - 9% = Rs.400
(2 Marks)
(iv) MM’s Model:
250 = 12 + P1 / 1.12 i.e. P1 = Rs.268
(2 Marks)
Q2
Valuation of Shares as per Gordon’s Dividend Model:
Year
1
2
3
4
5
6
7
8
9
10
10
EPS
D/P
Ratio
2.48 20 %
3.08 20 %
3.81 20 %
4.73 20 %
5.86 20 %
7.04 30 %
8.16 40 %
9.14 50 %
9.87 60 %
10.47 70 %
DPS
0.496
0.616
0.762
0.946
1.172
2.112
3.264
4.570
5.922
7.329
PVF
(15.75%)
.864
.746
.645
.557
.481
.416
.359
.310
.268
.232
84.609*
.232
PV
0.4285
0.4595
0.4915
0.5269
0.5637
0.8786
1.1718
1.4167
1.5871
1.7003
9.2246
19.6482
28.8728
(5 Marks)
Cost of equity for high growth and transition period:
ke = 7.5 + 1.5 [5.5] = 15.75 %
(1 Mark)
Cost of equity for stable period:
ke = 7.5 + 1 [5.5] = 13 %
(1 Mark)
*Continuing Value of Dividend:
Continuing value = 7.329 + 4 % / 13 % – 4 % = 84.6907
(2 Marks)
Recommendation: The current MPS (Rs.35) is higher than fundamental value of
share (Rs.28.87). Thus, the share is overpriced and hence not worth purchasing.
(1 Mark)
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Q3
(i)
Current MPS:
EPS = 150 / 10 = Rs.15
Current MPS = 15 X 12 = Rs.180
(1 Mark)
(ii)
Subscription price of Rights:
Subscription Price = 180 (1 - .30) = Rs.126
(iii)
Total number of rights shares and rights ratio:
Total rights to be issued = 378 / 126 = 3 lakhs
Rights ratio = 3 / 10 i.e. 0.3
(iv)
Ex-Rights Price:
Additional after tax earnings from new project = 378 X 15% = Rs.56.7 lakhs
Synergy generated from new project = 56.7 X 12 = Rs.680.4 lakhs
(1 Mark)
(1 Mark)
Ex-rights Price
= MN + Synergy / N + r
= 180 (10) + 680.4 / 10 + 3
= Rs.190.8
(2 Marks)
(v)
Impact on Wealth of Shareholder:
The rights ratio is 0.3. Investor has purchased 3,000 shares. Rights issue shall give
additional 900 shares which may be subscribed or sold.
e
f
Pre Rights Wealth
[3,000 X 180]
Value of shares if rights are subscribed
[3,900 X 190.8]
Cost of buying rights shares
[900 X 126]
Value of shares if rights are sold
[3,000 X 190.8]
Sale of rights [190.8 – 126 = 64.8 X 900]
Post Rights Wealth
g
Impact on Wealth [f – a]
a
b
c
d
Rights are
Subscribed
Rights are
Sold
5,40,000
5,40,000
7,44,120
N.A.
1,13,400
N.A.
N.A.
5,72,400
N.A.
6,30,720
[b – c]
90,720
58,320
6,30,720
[d + e]
90,720
(5 Marks)
Solution prepared by
CA. Ashish Lalaji
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