Question

A firm that 50,000 outstanding shares is planning to offer a DPS of 2.5. The price per share today is INR 55.

The firm is all equity financed and currently has a cash balance of INR 5 lakhs.

What is the cash balance and price per share after the dividend payout? You hold 1200 shares of this firm.

You are upset that the firm has paid you dividend and want to undo the dividend effect from your port- folio?

What will be the choice to negate the dividend payout given to you at the best extend possible and go to the status quo of pre-dividend period?

Answer 1

As the firm wil pay out the dividend from its retained earnings and it has a similar effect on ts cash balance.

The dvdend to be paid is 2.5 INR, so the dividend payout is

50000*2.5 =125,000 INR

The cash balance reduces by 125,000 INR and stands at INR 5 lakhs- INR 1.25 lakhs

So, the new cash balance is 5-1.25 = 3.75 lakh INR

The price per share after the dividend payout willbe the original price of the share less the dicidend paid

So, price ex-dividend = 55-2.5 = INR 52.5

I initially had a holding of 1200 shares, valued at 1200*55 = 66,000 INR but due to dividend payout my holding has reduced to 1200*52.5 = 63,000 INR

IfI want to return to the status quo of the pre dividend period, I can make use of the cash from the dividends received and buy an equivalent amount of shares of the firm

I have received a dividend of 1200*2.5 = 3000 INR. I can use this to buy 3000 INR worth of shares of the firm, now priced at 52.5

So, my shareholding increases to 1200 + 3000/52.5 =1257(rounded down)

Now my shareholding is valued at 1257*52.5 = 65,992.5 INR almost close to my status quo pre-dividend.