X Ltd. belongs to a risk class for which the approximate capitalisation rate is 10%. It currently has outstanding 2,500 shares selling at ₹100 each. The company is contemplating the declaration of dividend of ₹5 per shar

Answer 2A(ii) P 1 = Price of the share at the end of year 1 P 0 = Current price of the share K e = Cost of equity D 1 = Dividend at end of year 1 Value of the firm when dividends are paid P 0 = (D 1 + P 1 ) / (1+K e ) 100 = (5 + P 1 ) / (1+0.10) P 1 = ₹105 Amount required to be raised from the issue of new shares n 2 P 1 = I - (E - n 1 D 1 ) = 50,000 - [25,000 - (2500 x 5)] = ₹37,500 No. of additional shares to be issued n 2 = 37,500 / 105 shares Value of the firm = ((n 1 + n 2 )P 1 - I + E) / (1+K e ) = ((2500 + 37500/105)105 - 50,000 + 25,000) / (1+0.10) = ₹2,50,000 Value of the firm when dividends are not paid P 0 = (D 1 + P 1 ) / (1+K e ) 100 = (0 + P 1 ) / (1+0.10) P 1 = ₹110 Amount required to be raised from the issue of new shares n 2 P 1 = I - (E - n 1 D 1 ) = 50,000 - 25,000 = ₹25,000 No. of additional shares to be issued n 2 = 25000 / 110 shares Value of the firm = ((n 1 + n 2 )P 1 - I + E) / (1+K e ) = ((2500 + 25000/110)110 - 50,000 + 25,000) / (1+0.10) = ₹2,50,000 So, the value of the firm remains same whether dividend is declared or not declared.