Q51010 Following are the details regarding three companies X Ltd., Y Ltd. and Z Ltd.

	X Ltd.	Y Ltd.	Z Ltd.
Internal Rate of return (%)	5	20	15
Cost of equity capital (%)	15	15	15
Earning per share	` 10	` 10	` 10

Calculate the value of an equity share of each of those companies applying Walter’s formula when dividend payment ratio (DIP) ratio is (a) 75% (b) 50% (c) 80%.

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Solution:

Value of an equity share according to Walter’s formula is:

Where,

V_c= Market value of the ordinary share of the company.

R_a = Return on internal retention i.e. the rate company earns in retained profits.

R_c = Capitalisation rate i.e. the rate expected by investors by way of return from particular category of shares.

E = Earnings per share D = Dividend per share

Conclusions:

X Ltd.: This company may be considered as declining firm because IRR is lower than the cost of capital. It will therefore, be appropriate for this company to distribute the earnings among its shareholders.

Y Ltd.: This company may be considered as going firm because IRR is higher than the cost of capital. It will therefore, be appropriate for this company to retain the earnings.

Z Ltd.: This company may be considered as normal firm because IRR is equal to the cost of capital. D/P has no impact on value per share.

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