SOC Ltd has 10 lakh equity shares outstanding at the beginning of the accounting year 2024. The existing market price per share is 600. Expected…

CA Intermediate · Financial Management and Strategic Management · MTP · May 2024
SOC Ltd has 10 lakh equity shares outstanding at the beginning of the accounting year 2024. The existing market price per share is 600. Expected dividend is 40 per share. The rate of capitalization appropriate to the risk class to which the company belongs is 20%. (i) CALCULATE the market price per share by the end of the year when expected dividends are: (a) declared, and (b) not declared, based on the Miller – Modigliani approach. (ii) CALCULATE the number of shares to be issued by the company at the end of the accounting year on the assumption that the net income for the year is 15 crore; investment budget is 20 crores, when (a) Dividends are declared, and (b) Dividends are not declared. (iii) PROVE that the market value of the shares at the end of the accounting year will remain unchanged irrespective of whether (a) Dividends are declared, or (ii) Dividends are not declared.

Suggested Answer and Working Notes:

(a) (i) Calculation of market price per share According to Miller – Modigliani (MM) Approach: P 0 = (P 1 + D 1 ) / (1 + K e ) Where, Existing market price (P 0 ) = 600 Expected dividend per share (D 1 ) = 40 Capitalization rate (k e ) = 0.20 Market price at year end (P 1 ) = ? a. If expected dividends are declared, then 600 = (P 1 + 40) / (1 + 0.2) 600 x 1.2 = P 1 + 40 P 1 = 680 b. If expected dividends are not declared, then 600 = (P 1 + 0) / (1 + 0.2) 600 x 1.2 = P 1 P 1 = 720 (ii) Calculation of number of shares to be issued (a) Dividends are declared (₹ lakh) (b) Dividends are not Declared (₹ lakh) Net income 1500 1500 Total dividends (400) - Retained earnings 1100 1500 Investment budget 2000 2000 Amount to be raised by new issues 900 500 Relevant market price (₹ per share) 680 720 No. of new shares to be issued (in lakh) 900 ÷ 680 = 1.3235 500 ÷ 720 = 0.6944 (iii) Calculation of market value of the shares Particulars (a) Dividends are declared (b) Dividends are not Declared Existing shares (in lakhs) 10.00 10.00 New shares (in lakhs) 1.3235 0.6944 Total shares (in lakhs) 11.3235 10.6944 Market price per share (₹) 680 720 Total market value of shares at the end of the year (₹ in lakh) 11.3235 × 680 = 7,700 (approx.) 10.6944 × 720 = 7,700 (approx.) Hence, it is proved that the total market value of shares remains unchanged irrespective of whether dividends are declared, or not declared.

Topics: Part-A: Financial Management

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