Page 205 - DMGT409Basic Financial Management

Basic Financial Management

Notes At 50% payout ratio
4 0.12/0.12(8-4)
+
P=
0.12
= ` 66.66
At 75% payout ratio
+
6 0.12/0.12(8-6)
P=
0.12
= ` 66.66
At 100% payout ratio

+
8 0.12/0.12(8–8)
P=
0.12
= ` 66.66
Therefore, when R=K, price per share remains the same at all payout ratios. So, there is no one-
payout ratio, which is optimum.

Task Given the following information about ABC Ltd. Show the effect of the dividend
policy on the market price per share, using Walter’s model.
EPS = `9, Cost of capital (K) = 14%

Assumed rate of return
1. 15%
2. 10%
3. 14%

13.1.2 Gordon’s Model

Another theory, which contents that dividends are relevant, is the Gordon’s model. This model
which opines that dividend policy of a firm affects its value is based on the following

Assumptions

The key assumptions of Gordon’s model are as follows:
1. The firm is an all equity firm (no debt).

2. There is no outside financing and all investments are financed exclusively by retained
earnings.

3. Internal rate of return (R ) of the firm remains constant.

4. Cost of capital (K ) of the firm also remains same regardless of the changes in the risk
complexion of the fi rm.
5. The firm derives its earnings in perpetuity.

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