Tutorial 10 (Questions)

Corporate Finance BBA2103

2. Mondrian plc is a newly formed company which aims to maximise the wealth of its
shareholders. The board of directors of the company is currently trying to decide upon
the most appropriate dividend policy to adopt for the company’s shareholders.
However, there is strong disagreement between 3 of the directors concerning the
benefits of declaring cash dividends:

i. Director A argues that cash dividends would be welcomed by investors, and that as high
a dividend payout ratio as possible would reflect positively on the market value of the
company’s shares.
ii. Director B argues that whether a cash dividend is paid or not is irrelevant in the context
of shareholder wealth maximisation.
iii. Director C takes an opposite view to Director A and argues that dividend payments
should be avoided as they would lead to a decrease in shareholder wealth.

Required:

(a) Discuss the arguments for and against the position taken by each of the 3
directors.
(b) Assuming the board of directors decides to pay a dividend to shareholders, what
factors should be taken into account when determining the level of dividend
payments ?

3. Brighton plc has recently obtained a listing on the Stock Exchange. 90% of the
company’s shares were previously owned by members of one family, but, since the
listing, approximately 60% of the issued shares have been owned by other investors.
Brighton’s earnings and dividends for the 5 years prior to the listing are detailed below:

Years prior to listing Profit after tax (£) Dividend per share (£)
5 1,800,000 0.036
4 2,400,000 0.048
3 3,850,000 0.0616
2 4,100,000 0.0656
1 4,450,000 0.0712
Current year 5,500,000 (estimate)

The number of issued ordinary shares was increased by 25% 3 years prior to the listing and by
50% at the time of the listing. The company’s authorised capital is currently £25,000,000 in
£0.25 ordinary shares, of which 40,000,000 shares have been issued. The market value of the
company’s equity is £78,000,000. The board of directors is discussing future dividend policy.
An interim dividend of £0.0316 per share was paid immediately prior to the listing and the
finance director has suggested a final dividend of £0.0234 per share. The company’s declared
objective is to maximise shareholder wealth. The company’s profit after tax is generally

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expected to increase by 15% per annum for 3 years, and 8% per year after that. Brighton’s cost
of equity capital is estimated to be 12% per year. Dividends may be assumed to grow at the
same rate as profits.

Comment upon the nature of the company’s dividend policy prior to the listing and discuss
whether such a policy is likely to be suitable for a company listed on the Stock Exchange.

4. Newcastle plc is a public-listed firm. Its earnings and dividends for 6 years after its Initial
Public Offering (IPO) are shown below:

Years after IPO Profit after tax (£) Dividend per share (£)
6 4,400,000 0.051
5 5,600,000 0.072
4 6,800,000 0.096
3 7,700,000 0.1232
2 8,200,000 0.1312
1 8,900,000 0.1424
0 11,000,000

Further Information
• The quantity of ordinary equity had increased by 10% after the 3rd year.
• The quantity of ordinary equity had increased by 20% after the IPO until the 3rd year.
• The no. of shares the firm issued is 50,000,000 shares.
• The market capitalisation of the firm is £156,000,000.
• The cost of equity is 15% per annum.
• The company’s goal is to maximise shareholders’ wealth.
• After year 6, dividends will grow at a constant rate of 10% forever.

Required :
(a) Critically examine the company’s dividend policy after its IPO and evaluate whether
such a policy is good for the firm.

(b) Evaluate whether Newcastle’s shares are undervalued or overvalued. Calculations need
to be provided wherever is applicable.

(c) Examine the weaknesses of the model that you used in (b).

(d) John told William that he just received a dividend worth £0.20/share from his equity
investment. He further told William that this dividend definitely worth more than those
dividend from the same equity which are going to be paid in the future. Do you agree
or disagree with John’s statement to William ? Justify your stance with proper
explanations.

(e) Robert told Peter that dividend is not relevant to investors as the latter can sell their
equity anytime to earn returns. Discuss critically why the “Dividend Irrelevance
Theorem” as suggested by Robert is not realistic in the real world.