Question

5. Assuming the rate of return expected by investor is 11%, Internal rate of return is 12%; and the earnings per share is Rs.15, Calculate price per share by Gordon Approach method if dividend payout ratio is 10% and 30%.

Answer 1

The answer is Rs. 750 and Rs. 173.08

Given:

Assuming the rate of return expected by investor is 11%, Internal rate of return is 12%; and the earnings per share is Rs.15,

To find:

Calculate price per share by Gordon Approach method if dividend payout ratio is 10% and 30%.

Solution:

The Gordon's Model states that a company's dividend policy is important.

can have an impact on a company's worth. like the value of the Walter's Model

Reinvestment rate (r) and company under this methodology

investor expectations ( $k_{e}$).

This is predicated on the idea that investors are often risk-averse people who want to receive current income, such as dividends. thus there

is a direct correlation between a company's dividend policy and its value.

firm.

According to Gordon’s Model

P =[ E(1-b)]/[ $k_{e}$ - br]

P = Market price of equity share.

E = Earnings per share.

b = Retention ratio.( 1 – payout ratio)

r = Rate of return on investment.

$k_{e}$ = Cost of equity capital.

br = Growth rate of the firm.

When D/P Ratio is 10% P = [15 * (1-0.90)]/ [0.11 - (0.90 * 0.12)] = 1.5/ 0.002 = Rs. 750

When D/P Ratio is 30%, P = [15 * (1-0.70)]/ [0.11 - (0.70 * 0.12)]= 4.5/0.026 = Rs. 173.08

Hence, the answer is Rs. 750 and Rs. 173.08.

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