RST Ltd. has a capital of ₹ 10,00,000 in equity shares of ₹ 100 each. The shares are currently quoted at par. The company proposes to declare a dividend of ₹ 10 per share at the end of the current financial year. The cap

CS Executive · Corporate Accounting and Financial Management · PYQS · December 2023
RST Ltd. has a capital of ₹ 10,00,000 in equity shares of ₹ 100 each. The shares are currently quoted at par. The company proposes to declare a dividend of ₹ 10 per share at the end of the current financial year. The capitalization rate for the risk class of which the company belongs is 12%. You are requested to calculate market price of the share at the end of the year, if (i) Dividend is not declared. (ii) Dividend is declared. (iii) Assuming that the company pays the dividend and has net profits of ₹ 5,00,000 and makes new investments of ₹ 10,00,000 during the period, how many new shares must be issued ? Use the MM model.

Answer & Explanation:

Calculation of Market Price of Share and New Shares Issued using MM Model Given: Capital = ₹ 10,00,000 Face Value per share = ₹ 100 Number of shares (n) = ₹ 10,00,000 / ₹ 100 = 10,000 shares Current Market Price (P0) = ₹ 100 (quoted at par) Proposed Dividend per share (D1) = ₹ 10 Capitalization Rate (Ke) = 12% or 0.12 MM Model Formula: P0 = (D1 + P1) / (1 + Ke) Where: P0 = Current Market Price per share D1 = Dividend per share at the end of the year P1 = Market Price per share at the end of the year Ke = Cost of Equity / Capitalization Rate (i) Market Price of the Share at the end of the year if Dividend is NOT declared (D1 = 0): ₹ 100 = (₹ 0 + P1) / (1 + 0.12) ₹ 100 = P1 / 1.12 P1 = ₹ 100 × 1.12 = ₹ 112 Market Price per share at the end of the year (P1) = ₹ 112 (ii) Market Price of the Share at the end of the year if Dividend IS declared (D1 = ₹ 10): ₹ 100 = (₹ 10 + P1) / (1 + 0.12) ₹ 100 = (₹ 10 + P1) / 1.12 ₹ 100 × 1.12 = ₹ 10 + P1 ₹ 112 = ₹ 10 + P1 P1 = ₹ 112 - ₹ 10 = ₹ 102 Market Price per share at the end of the year (P1) = ₹ 102 (iii) Number of new shares to be issued (using MM model): Assuming dividend is paid (D1 = ₹ 10), Net Profits (E) = ₹ 5,00,000, New Investments (I) = ₹ 10,00,000. Total funds required for investment = ₹ 10,00,000 Net Profits available = ₹ 5,00,000 Total Dividend paid = Number of shares × D1 = 10,000 shares × ₹ 10 = ₹ 1,00,000 Retained Earnings = Net Profits - Dividend Paid = ₹ 5,00,000 - ₹ 1,00,000 = ₹ 4,00,000 Funds to be raised from new issue = Total Investments - Retained Earnings = ₹ 10,00,000 - ₹ 4,00,000 = ₹ 6,00,000 Market Price per share at the end of the year (P1, when dividend is declared) = ₹ 102 (from part ii) Number of new shares to be issued (Δn) = Funds to be raised from new issue / P1 = ₹ 6,00,000 / ₹ 102 = 5,882.35 shares Approximately 5,883 shares must be issued.

Topics: Financial Management

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