M Ltd. belongs to a risk class for which the capitalization rate is 12%. It has 40,000 outstanding shares and the current market price is 200. It…

Given, Cost of Equity (Ke) 12% Number of shares in the beginning (n) 40,000 Current Market Price (Po) 200 Net Profit (E) 5,00,000 Expected Dividend (D1) 10 per share Investment (I) 10,00,000 Situation 1 - When dividends are paid (i) Po = (P1+D1)/(1+Ke) 200 = (P1+10)/(1+0.12) P1 + 10 = 200 x 1.12 P1 = 224 - 10 = 214 (ii) Calculation of funds required = Total Investment - (Net profit - Dividend) = 10,00,000 - (5,00,000 – 4,00,000) = 9,00,000 (iii) No. of shares required to be issued for balance fund No. of shares = Funds Required / Price at end (P1) Δn = 9,00,000 / 214 = 4,205.61 (iv) Calculation of value of firm V1 = ((n+Δn)P1−I+E)/(1+Ke) = ((40,000 + 4,205.61) * 214 - 10,00,000 + 5,00,000) / (1+0.12) = (94,60,000 - 5,00,000) / 1.12 = 80,00,000 Situation 2 - When dividends are not paid (i) Po = (P1+D1)/(1+Ke) 200 = (P1+0)/(1+0.12) P1 + 0 = 200 x 1.12 P1 = 224 - 0 = 224 (ii) Calculation of funds required = Total Investment - (Net profit - Dividend) = 10,00,000 – (5,00,000 - 0) = 5,00,000 (iii) No. of shares required to be issued for balance fund No. of shares = Funds Required / Price at end (P1) Δn = 5,00,000 / 224 = 2,232.14 (iv) Calculation of value of firm V1 = ((n+Δn)P1−I+E)/(1+Ke) = ((40,000 + 2,232.14) * 224 - 10,00,000 + 5,00,000) / (1+0.12) = (94,60,000 - 5,00,000) / 1.12 = 80,00,000