M08EFA Worksheet Nine

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1. Discuss the reasons why a firm may pay a “special dividend”.

2. Would you expect the following companies to have a high low payout ratio?
a. Young, growth companies
b. A company experiencing a temporary decline in profits
c. Companies with volatile earnings
d. A company that expects future profits to be lower

3. Sphere Plc is an all equity firm having 200,000 shares and total market
value of £100,000. The firm has announced a 5p dividend with an XD date
of tomorrow. (Assume no tax)
a. What will the share price be today?
b. What will it be tomorrow?
If the company lacks the capital to pay the dividend, show how it could fund
the dividend by issuing shares.

4. Discuss the reasons why a firm may decide to repurchase its own shares.
How does this relate to the agency problem?

5. Discuss the key factors that are likely to determine a firm’s overall dividend
policy
 M08EFA Worksheet Nine
Class
 
1. ISE plc has forecasted the following cash flows from operating activities (after interest
and taxation) for the next five years as follows. All cash flows have been calculated
before the deduction of additional investment in fixed capital and working capital.

Year Net Cash Flow

1 £3,800,000
2 £4,500,000
3 £8,800,000
4 £10,250,000
5 £10,500,000

Management believe additional investment will amount to £0 million in the first year, £3
million in year two and £4.2 million for each year thereafter. The firm currently has a
cash balance of £3 million, has 20 million shares in issue and has already committed to
paying a dividend of 19p in Year 1.
 
a. Calculate the annual cash flows available for dividend payments and the dividend
per share if a residual policy was strictly adhered to.
b. Determine if directors have sufficient cash reserves to switch to a smooth
dividend policy based on steady 10% increase in dividends per year.
c. Discuss the advantages and disadvantages of each policy
d. Are they any opportunities for special dividends under either of the above
options?

2. You purchased 3000 shares at £1.50 a year ago. Today they are worth £3. The company
announced a 50p dividend with an XD date of tomorrow. If you need to liquidate your
entire holding, would your best policy be to sell today or tomorrow if:
a. You pay 10% tax on dividend income and zero on capital gains?
b. You pay 10% tax on dividend income and 18% tax on capital gains?
c. You pay 32.5% tax on dividend income and 18% tax on capital gains?

Show in each case the total tax liability created by selling today or selling tomorrow.

3. GHK Plc is worth £100m. It currently has 250m shares in issue. Rather than pay a 20p
dividend it has decided to use an equivalent amount of money to repurchase its own
shares.

a. How many shares will GHK repurchase?

b. What is the theoretical share price of GHK Plc likely to be after the share
repurchase is complete?
c. In practice, do you think the actual market price is likely to be higher or lower
than that calculated in b. above?