Pls solve this

ABC Ltd. has 50,000 outstanding shares.  The current market price per share is Rs.100 each.  It hopes to make a net income of Rs.5,00,000 at the end of current year.  The Company’s Board is considering a dividend of Rs.5 per share at the end of current financial year.  The company needs to raise Rs.10,00,000 for an approved investment expenditure.  The company belongs to a risk class for which the capitalization rate is 10%.  Show, how does the M-M approach affect the value of firm if the dividends are paid or not paid.

(6 Marks) (November, 2006)

Answer

When dividends are paid

100 = (5 + P₁)/(1 + 0.10)

Therefore, P1 = Rs.105/-.

Value of firm

= Rs.([50,000/-+7,50,000/-/105/-) x 105/-] – 10,00,000/- + 5,00,000/-)/1.10

= Rs.(60,00,000/- - 5,00,000/-)/1.10

= Rs.50,00,000/-.

When dividend is not paid

100 = 1/1.1 x P₁

Therefore, P₁ = Rs.110/-.

Value of firm

= Rs.([50,000/- +(5,00,000/-/110/-) x 110/-] – 10,00,000/-+5,00,000/-)/1.10

= Rs.(60,00,000/- - 5,00,000/-) / 1.10

= Rs.50,00,000/-

M.M. approach indicates that the value of the firm in both the situations will be the same.