Chapter 12 • The dividend decision
12.2 ‘According to Modigliani and Miller, shareholders are indifferent between a dividend
and a capital gain.’
Comment on this statement, which you have overheard.12.3*HLM plc, an all-equity-financed business, has just paid a dividend totalling £1.5 mil-
lion. This amount has been paid on a regular basis for many years, and the market
expects this to continue. The business has 10 million ordinary shares currently quoted
at £1 each. The directors have identified the opportunity to invest £1 million in one
year’s time, and a similar amount in two years’ time, in a project that will generate
an annual cash flow of £0.4 million for ever, starting in three years’ time. The only
posible way of financing this investment is by paying a reduced dividend for the next
two years.
If the directors were to announce their intention to make this investment and to pub-
lish full details of it and the financing method, what would happen to the share price?
Ignore taxation.12.4 Durodorso plc is a Stock Exchange listed business that has built up a cash mountain
equal in size to about 25 per cent of its market capitalisation as a result of the con-
tinuation of restricted dividend policy and a consistent failure to identify investment
opportunities. Since the directors continue to see no investment opportunities, a
decision has been made to use the cash to pay a ‘special’ dividend. When the direc-
tors met to discuss the special dividend, the finance director told the other directors,
‘We’ve always been modest dividend payers in the past so our shareholders would
probably welcome a large dividend.’
What would you advise the directors to do regarding the special dividend?12.5 ‘It is widely accepted that dividend valuation models are an acceptable way of valu-
ing businesses. Modigliani and Miller said that dividends are irrelevant to valuation
and so flew in the face of conventional wisdom.’
Is this statement correct? Explain.12.6*Images plc is an all-equity-financed, Stock Exchange listed business. It has been a
steady profit and cash flow generator over recent years, and it has distributed all of
its after-tax profit as dividends.
More recently, the business has been actively seeking new investment opportun-
ities. In the financial year that has just ended, it reported profits of £5 million, a figure
similarto that of recent years.
Four potential investment projects have been identified, all of which could commence
immediately. The estimated cash flows and timings of these projects are as follows:Year Project I Project II Project III Project IV
£ million £ million £ million £ million
0 (2.00) (2.00) (3.00) (1.00)
1 0.75 0.65 0.80 0.50
2 0.75 0.65 0.80 0.50
3 0.75 0.65 0.80 0.50
4 0.65 0.80
5 0.65 0.80Each of these projects falls within the same risk class as the business’s existing projects.