Page 203 - DMGT409Basic Financial Management

Basic Financial Management

Notes 2. Constant R, Internal rate of return cannot remain same. It actually diminishes as and when
we make more and more investments.
3. Constant K, Cost of capital of a company cannot remain same. Risk of the company
definitely changes with additional investments of retained earnings.

Illustration 1: Given the following information about Sunrise Industries Ltd. Show the effect of
the dividend policy on the market price per share, using Walter’s model.
EPS = `8
Cost of capital (K) = 12%

Assumed rate of return
1. 15%
2. 10%
3. 12%

Solution:
To show the effect of different dividend policies on the shareholders of the firm for 15% and 12%,

let us consider 0%, 25%, 50%, 75% and 100% payout ratios.
I when R>K (15>12)

At 0% payout ratio (dividend=0)
−
+
DR /K (E D )
P =
K
−
+
0 0.15/0.12(8 0)
=
0.12
= ` 83.33
At 25% payout ratio.
2 + 0.15/0.12(8-2)
P=
0.12
= ` 79.16
At 50% payout ratio
4 + 0.15/0.12(8-4)
P=
0.12

= ` 75.
At 75% payout ratio
6 + 0.15/0.12(8-6)
P=
0.12
= ` 70.83
At 100% payout ratio
+
8 0.15/0.12(8-8)
P=
0.12
= 66.67

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