Page 251 - Corporate Finance PDF Final new link

BRILLIANT’S Dividend Decision 251

Dividend Capitalization Model {S>{dS>oÝS> H¡${nQcmBOoeZ _m°S>c
According to Gordon, the market value of Jm°S>©Z Ho$ AZwgma, eo`a H$s _mH}$Q> d¡ë`y â`yMa
a share is equal to the present value of future {S>{dS>oÝS>g H$s dV©_mZ d¡ë`y Ho$ ~am~a hmoVr h¡Ÿ&
dividends.

1 b 
–
Symbolically, P = E
K – br
Where,
P = Price of the share. E = Earning Per Share
b = Percentage of earning distributed as dividends.
K = Cost of capital/Capitalization Ratio.
br = g = growth rate i.e. rate of return on investment.
br = b × r i.e. Retention ratio × growth rate
Dividend Policy and the Value of the firm
(GORDON'S MODEL)

Growth firm, r > K NPP Declining firm, r < K
Normal firm, r = K
Basic Data

r = 0.15 r = 0.10 r = 0.08
K = 0.10 K = 0.10 K = 0.10
EPS = ` 10 EPS = ` 10 EPS = ` 10

Payout Ratio, (1 - b) = 40%, Retention Ratio, b = 60%

g = br = 0.6 × 0.15 = 0.9 g = br = 0.6 × 0.10 = .06 g = br = 0.6 × 0.08 = 0.048
10 1 0.6  10 1 0.6  10 1 0.6 
P  P  P 

0.10 0.09 0.10 0.06 0.10 0.048
4 4 4
=  ` 400 = ` 100 = ` 77
0.01 0.04 0.052

Payout Ratio, (1 - b) = 60%, Retention Ratio, b = 40%

g = br = 0.4 × 0.15 = .06 g = br = 0.4 × 0.10 = 0.4 g = br = 0.4 × 0.08 = 0.032
10 1 0.4  10 1 0.4  10 1 0.4 
P  P  P 
0.10 0.06 0.10 0.04 0.10 0.032


6 6 6
=  ` 150 = ` 100 =  ` 88
0.04 0.06 0.068