Page 309 - DMGT405_FINANCIAL%20MANAGEMENT

Unit 14: Management of Surplus & Dividend Policy

Step 2: Amounts to be raised by the issue of new shares to finance investment requirement: Notes

N P = I – (E – nD )
1 1 1
= 500,000 – (350,000 – 25000 × 3)
= 225,000
Step 3: No. of shares to be raised
225000
n = Nos.
1 109
Step 4: Value of the firm

(n  n )P 1   E
I
1
nP =
0 (1  k )
e



(25,000  225,000/109) 109 (500,000) 350,000)
=
1.12
Value of the firm nP = 25,00,000
o
2. Value of the firm when dividends are not paid:
Step 1: Price per share at the end of year I
1
P = (D 1  P )
1
0 (1  k )
e
P 1
100 = Or
1.12
P = 112
1
Step 2: Amount to be raised from the issue of shares
500,000 – 350,000 = 150,000
Step 3: No. of shares to be raised = 150,000/1.12

Step 4: Value of the firm
I
(n  n )P 1   E
1
nP =
0 (1  k )
e
(25,000  150,000/1.12) 1.12 (500,000) 350,000



=
1.12
Value of the firm nP = 25,00,000
o
Thus the value of the firm in both the cases remains the same.
Critical Analysis of the Assumptions
1. Tax effect: The assumption cannot be true since the tax rate for the dividend and capital
gains are different.
2. Floatation costs: The proceeds that the firm gets from the issue of securities are net off. the
issue expenses – the total issue expenses include underwriting expenses, brokerage and
other marketing costs, of the tune of 10 – 15% of the total issues in India. These high costs
cannot be ignored.

LOVELY PROFESSIONAL UNIVERSITY 303