Cash Dividend

Knowledge
K1. Critical understanding of the key strategic decisions that a business may have to make and appreciated how accounting and finance can assist in making and evaluating those decisions
K2. Critical understanding of specific analytical skills in key decision areas within strategy and finance at local and international level
K3. Critical understanding of the limitations of the current state of financial theory in making strategic business decisions

Skills
S1. Competence in applying the key valuation concepts and methodologies of financial decision making in order to contribute to the wider decision making of the organisation

Requirements:
You must answer any TWO questions. Each question that is attempted will carry a maximum mark of 50%

Question 1 – Dividend Policy
(a) Planet has just announced an ordinary dividend per share of 20p. The past four years’ dividends per share have been 13p, 14p, 17p and 18p (most recent dividend last) and shareholders require a return of 14 per cent. What is a fair price for Planet’s shares? (25 marks)
(b) Planet now decides to increase its debt level, thereby increasing the financial risk associated with its equity shares. As a consequence, Planet’s shareholders increase their required rate of return to 15.4 per cent. Calculate a new price for Planet’s shares. (10 marks)
(c) Outline any problems with using the dividend growth model as a way of valuing shares. (15 marks)
Total (50 marks)

Question 2 – Long term finance: Equity finance
(a) Brand plc generates profit after tax of 15 per cent on shareholders’ funds. Its current capital structure is as follows:
Ordinary shares of 50p each  £200,000
Reserves  £400,000
£600,000
The board of Brand plc wishes to raise £160,000 from a right issue in order to expand existing operations. Its return on shareholders’ funds will be unchanged. The current ex-dividend market price of Brand plc is £1.90. Three different rights issue prices have been suggested by the finance director: £1.80, £1.60 and £1.40.
Determine the number of shares to be issued, the theoretical ex-rights price, the expected earnings per share and the form of the issue for each rights issue price. Comments on your results.

(30 marks)
(b) It has become common for companies to offer their shareholders a choice between a cash dividend and an equivalent scrip dividend. Briefly consider the advantages of scrip dividends from the point of view of:
(i) the company;
(ii) the shareholders.
(20 marks)