The earning per share for Avanti Corporation is Rs. 40. The rate of return on investments is 16 per…
Walter's model: P = [D + (r ÷ Ke)(E − D)] ÷ Ke. With E = Rs. 40 and a 40% payout, D = Rs. 16 and retained earnings = Rs. 24; with r = 0.16 and Ke = 0.12, P = [16 + (0.16 ÷…
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The earning per share for Avanti Corporation is Rs. 40. The rate of return on investments is 16 per cent and the return required by iits shareholders is 12 percent. What will be the price per share as per the Walter model, if the payout ratio is 40 per cent?
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Correct answer C
Walter's model: P = [D + (r ÷ Ke)(E − D)] ÷ Ke. With E = Rs. 40 and a 40% payout, D = Rs. 16 and retained earnings = Rs. 24; with r = 0.16 and Ke = 0.12, P = [16 + (0.16 ÷ 0.12) × 24] ÷ 0.12 = (16 + 32) ÷ 0.12 = Rs. 400. Because r exceeds Ke, retaining earnings adds value: the dividend alone capitalised at 12% is worth only about Rs. 133, and the smaller prices offered do not follow from the formula.
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UGC NET Commerce