ProblemsIt has been estimated that the cost of equity is 15 per cent p.a.
The directors would be very reluctant to raise outside funds to help finance any of
the above projects.
What advice would you give the directors as to the level of dividend that should be
paid this year?12.7 The directors of Bellini plc, a Stock Exchange listed business, are contemplating the
business purchasing some of its own shares in the market, and cancelling them, as
an alternative to paying a dividend. Some of the directors believe that certain share-
holders would prefer this.
What considerations should the directors particularly take into account when making
this decision?
12.8 Breadwinner plc, a £500 million market value, all-equity-financed listed business, has
been in the habit of making just one dividend payment each year. The business has
just paid a dividend of 21p a share. This dividend represents an increase of 5 per cent
on the dividend paid just over a year ago, and the share’s current market price is
thought to be based on the expectation that this growth rate will continue indefinitely.
The business’s cost of equity is 10 per cent p.a.
The directors have identified a major investment project which requires significant
outlays of cash over the forthcoming two years. It is the business’s policy to finance
all investments from retained profits, which means that, to make the investment, there
could be no dividend payment for the next two years. The next dividend would be in
three years’ time at an estimated 40p per share, but this would be expected to grow
at an annual rate of 6 per cent indefinitely from that time. It is estimated that the riskier
nature of the investment project would increase the overall cost of equity to 12 per cent.
The directors are about to announce their intention to go ahead with the invest-
ment. Ms Jenkins owns some of the shares, the dividends from which she relies on
to supplement her state retirement pension. This holding represents her only wealth
apart from the freehold of the bungalow in which she lives.
(a) Show and explain calculations that indicate the theoretical expected alteration in
the company’s current share price when the announcement of the investment and
dividend plans is made.
(b) Explain why the theoretical alteration in the business’s share price may not occur
in practice.
(c) Advise Ms Jenkins on what she should do in response to the announcement, pre-
suming that she wishes to remain a shareholder in Breadwinner plc. This advice
should include the theoretical and practical effects on Ms Jenkins’s wealth and
income of any actions that she might take.
(d) Advise Ms Jenkins more broadly on her investment strategy. This advice should
clearly explain the issues involved and any costs that may result from taking your
advice.
12.9 Butterworth plc is a UK listed business. For many years it has paid an annual dividend
on its ordinary shares that was 8 per cent higher than that of the previous year. The
market expects that this pattern will continue. The dividend paid just under a year ago
was £0.43 per share. The current cum-dividend share price is £6.78.
An opportunity has arisen for the business to undertake a project that will re-
quire an immediate outflow of cash equal to the amount of the planned dividend. The
cash that was to be used for the dividend is the only source of cash for the project.
The project will have just one cash payoff, which will occur in three years’ time. The ‘