Dividend Decision – CA Final SFM

Basic Formulas

S. No.
Formula
1.
Dividend Rate
DPS * 100
Face Value
2.
Dividend Per Share   (DPS)
Total Dividend
No. of Share
3.
Dividend Payout Ratio (DPR)
DPS*100
EPS
4.
Dividend Yield Ratio
DPS*100
Market Price
5.
Retention Ratio
(EPS – DPS)*100
EPS
6.
Market Capitalization
Share Price * No. of Share Outstanding
7.
Price Earnings Ratio
Price
EPS
8.
Quadratic Equation – X =
- b ± √ (b2 – 4ac)
2a
9.
ROI
EPS
BVPS
10.
Growth (g)
b x r          (where b is retention ratio)
11.
Compounded Annualized Growth Rate (CAGR)
(Closing Value)1/n – 1
                     Opening Value


Cost of Capital

S. No.
Name of Method
Formula
Remarks
1.
Dividend Growth Model/Dividend Discount Model
Ke =
D1  + g
           Price   
Where g is Growth
2.
Capital Assets Pricing Model (CAPM)
Ke =
Rf + β(R­m – Rf)
Where β is Systematic Risk of Security and Rf is Risk Free Return from Market, (R­m – Rf) is Market Risk Premium and β(R­m – Rf) is Security Risk Premium
3.
Earning Yield Method
Ke=
EPS X 100
           Price

4.
Base on Price Earnings Ratio
Ke=
1
PER
Where PER is Price Earnings Ratio, PER = Price
          EPS



Share Price
S. No.
Name of Method
Formula
Remarks
1.
Traditional Approach (Graham & Dodd Model)
Price =
M(D + E)
           3
Or
M (4D + RE)
       3
M is Multiplier
D is Dividend Per Share
E is Earning Per Share
RE is Retained Earning

2.
Walter’s Approach
Price =
D + (E – D) x r
    Ke                   Ke
Ke
r = Rate of Return on Investment
E =  Earnings Per Share
Ke = Weighted Average Cost of Capital
Note: - If r > Ke then share price would be maximum at 0% dividend payout.(Growth Firm)
Note: - If r < Ke then share price would be maximum at 100% dividend payout.(Declining Firm)
Note: - If r=Ke then there is no impact on share price due to dividend policy i.e. Dividend policy is irrelevant. (Normal Firm)

Walter’s Approach is also called all or nothing approach (all = 100%  payout & Nothing = 0% Payout)    
3.
Gordon Growth Model
Price
                 D1             
Ke - g
D1 is Next Year Dividend,
Assumption of Gordon’s Growth Model: -
1. The firm is all equity firm and it has no debt.
2. Source of finance is retained earnings and no other alternative to raise finance.
3. Internal rate of return (r) & cost of capital (Ke) remains constant.
4. The firm has perpetual life.
5. Retention ratio once decided remains constant.
6. Discount Rate is greater than growth rate (Ke > g).
4.
Dividend Discount Model (When No Growth)

When Constant Growth

When Different Growth

Price =



Price=


Price =
D
Ke


D1
Ke – g

D1/(1+Ke)1 + D2/(1+Ke)2 + D3/(1+Ke)3 + …… Up to Different Growth + (Dn-1/Ke-g)/(1+Ke)n

5.
Lintner’s Model       
D1 =
D0 + (EPS x DPS – D0) x Adjustment Factor

6.
Modigilani  - Millar Model
P0 =
P1 + D1
1+ Ke
P0 = Current Market Price
P1 = Market Price at Year end
nP0 =  Current Value of Firm
n = Present No. of Shares
m = Additional Shares at year end market price
I1 = Investment to be made at year end
 X1 = Earing During Year
Np0 =
(n + m) x P1 – I1 + X1
1 + Ke


Steps for Value of Firm by M-M Approach

Step I – Share Price after 1 Year (P1)
Step II - Income after 1 Year (X1)
Step III – Dividend after 1 Year (D1)
Step IV – Retained Earnings after 1 Year (X1 – D1)
Step V – Investment to be done after 1 Year (I1)
Step VI – Balance amount to be raised from Equity Market (I1 –R1) at (P1)
Step VII – New Share to be issued (m = Step/ P1)
Step VIII – Market Value after 1 Year (n + m) x P1
Step IX – Calculation of P0 from value in Step VIII. Value from this step should be equal to the value of firm at P­0.

Decision Making
I.  If fundament Price is greater than actual market price then –
Stock is undervalued
Buy Recommendation

II. If Fundamental price is less than actual market price then-
Stock is overvalued
Sell Recommendation

III. If fundamental price is equal to actual market price then-
Stock is valued correctly
Hold Recommendation if already purchased earlier.

Residual Payment Policy: - Residual Payment Policy means distribute retained earnings (profits) after making investment needs.

Trigger Point to identify D1 or D0
Points to Trigger D0 = Historical/Past/Paid/Last Year
Points to Trigger D1 =  Future/Expected/will pay/next year


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