Page 226 - DMGT207_MANAGEMENT_OF_FINANCES

Unit 9: Dividend Decisions

Solution: To prove that MM model holds good, we have to show that the value of the firm Notes
remains the same whether dividends are paid or not.
1. The value of the firm, when dividends are paid:

Step 1: Price per share at the end of year I
1
P = (d  P )
1
1
0 (1  k )
e
1
100 = (3  P )
1
1.12
P = 109
1
Step 2: Amounts to be raised by the issue of new shares to finance investment requirement:
N1P1 = I – (E – nD )
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   E
I
nP = 1 1
0 (1  k )
e


(25,000  225,000/109) 109 (500,000) 350,00)
=
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  P )
1
1
0 (1  k )
e
P
100 = 1
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   E
1
1
nP =
0 (1  k )
e

(25,000  150,000/1.12) 1.12  (500,000)  350,00)
=
1.12
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