Profitable FMCG company PQR Ltd. is examining its dividend policy considering potential future investment opportunities. The company's objective is…

CA Intermediate · Financial Management and Strategic Management · MTP · September 2025
Profitable FMCG company PQR Ltd. is examining its dividend policy considering potential future investment opportunities. The company's objective is to maintain a good financial strategy by balancing market valuation, financing requirements, and shareholder expectations. Following information has been provided: Equity Share Capital:20,00,000 (10 per share fully paid) Reserves and Surplus:30,00,000 Earnings After Tax (EAT):10,00,000 Return on Investment (r): 15% Cost of Equity (Ke): 12% Market Price per Share:80 Number of Equity Shares: 2,00,000 Current Debt-Equity Ratio: 0.5:1 Planned Investment Requirement:12,00,000 (next financial year) The Board of Directors of the company is considering three dividend payout options. Option A – 100% payout; Option B – 50% payout; and Option C – 0% payout. Further, because of the market conditions, no fresh equity will be raised. Any financial shortage must be covered by debt, but not more than a 1:1 debt-to-equity ratio. The corporate tax rate is 30%. Interest on debt is 10% per annum. You are required to: (i) Calculate the market price per share under each dividend payout option using Walter's Model. (ii) Evaluate the feasibility of internally funding the - 12,00,000 investment under each payout scenario. (iii) Determine the revised Debt-Equity Ratio assuming the shortfall is met through borrowing if the company adopts a 50% payout. (iv) Recommend the most suitable dividend policy.

Suggested Answer and Working Notes:

Division B: Descriptive Question 1. (a) (i) Market Price Per Share using Walter's Model Walter's Model Formula: P = [D + (r / Ke) × (E - D)] / Ke Option A: 100% payout (D = 5) P = [5 + (15% / 12%) × (5 - 5)] / 0.12 = 41.67 Option B: 50% payout (D = 2.5) P = [2.5 + (15% / 12%) × (5 - 2.5)] / 0.12 = 72.92 Option C: 0% payout (D = 0) P = [0 + (15% / 12%) × 5] / 0.12 = 104.17 Since the company earns more on retained earnings (r > Ke), lower payout leads to higher market price per share. (ii) Feasibility of Funding - 12,00,000 Investment Internally Investment Requirement = 12,00,000 EAT = 10,00,000 Retained earnings depend on payout ratio. The present situation can be summarized in the following table: Option Retained Earnings (₹) Shortfall (₹) Feasibility 100% payout 0 12,00,000 Feasible 50% payout 5,00,000 7,00,000 Feasible 0% payout 10,00,000 2,00,000 Feasible (iii) Revised Debt-Equity Ratio (if 50% payout is chosen) Existing Equity = 50,00,000 Existing Debt = 0.5 × ₹ 50,00,000 = 25,00,000 New Equity (post-retention):55,00,000 New Debt (after - 7,00,000 borrowing):32,00,000 Revised debt-equity Ratio = 32,00,000 /55,00,000 = 0.582 It is well within the 1:1 cap. (iv) Recommendation 0% payout is the best option as it has the highest market price which increases shareholders wealth.

Topics: Part-A: Financial Management

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