Tag (SQ): Dividend Policy

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  • 20 Marks

FR – L2 – Q99 – Presentation of Financial Statements

Calculate financial ratios for Jeck Ltd for the year ended 31 March 20X9 based on provided financial statements.

Jeck Ltd is a listed company that assembles domestic electrical goods which it then sells to both wholesale and retail customers. Jeck Ltd’s management was disappointed in the company’s results for the year ended 31 March 20X8. In an attempt to improve performance the following measures were taken early in the year ended 31 March 20X9:

  • A national advertising campaign was undertaken,
  • Rebates to all wholesale customers purchasing goods above set quantity levels were introduced,
  • The assembly of certain lines ceased and was replaced by bought-in completed products. This allowed Jeck Ltd to dispose of surplus plant.

Jeck Ltd’s summarised financial statements for the year ended 31 March 20X9 are set out below:

Statement of Financial Position as at 31 March 20X9

GH$’000 GH$’000
Non-current assets
Property, plant and equipment (note (ii)) 550
Current assets
Inventory 250
Trade receivables 360
Bank Nil
610
Total assets
Equity and liabilities
Stated capital (400m shares) 100
Income surplus 380
480
Non-current liabilities
8% loan notes 200
Current liabilities
Bank overdraft 10
Trade payables 430
Current tax payables 40
480
Total equity and liabilities

Statement of Profit or Loss and Other Comprehensive Income for the Year Ended 31 March 20X9

GH$’000
Revenue (25% cash sales)
Cost of sales
Gross profit
Operating expenses
Operating profit
Profit on disposal of plant (note (i))
Financial charges
Profit before tax
Income tax expense
Profit for the year

Below are ratios calculated for the year ended 31 March 20X8:

  • Return on year-end capital employed (profit before interest and tax over total assets less current liabilities): 17%
  • Net assets (equal to capital employed) turnover: 4 times
  • Gross profit margin: 6.3%
  • Net profit (before tax) margin: Not provided
  • Current ratio: 1.6:1
  • Closing inventory holding period: 46 days
  • Trade receivables’ collection period: 45 days
  • Trade payables’ payment period: 55 days
  • Dividend yield: 3.75%
  • Dividend cover: 2 times

Notes:
(i) Jeck Ltd received GH$120m from the sale of plant that had a carrying amount of GH$80m at the date of its sale.
(ii) The market price of Jeck Ltd’s share throughout the year averaged GH$3.75 each. There were no issues or redemption of shares or loans during the year.
(iii) Dividends paid during the year ended 31 March 20Y0 amounted to GH$90m, maintaining the same dividend paid in the year ended 31 March 20X9.

Required:
(a) Calculate ratios for the year ended 31 March 20X9 (showing your workings) for Jeck Ltd, equivalent to those provided above.

(b) Analyse the financial performance and position of Jeck Ltd for the year ended 31 March 20X9 compared to the previous year.

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  • 20 Marks

FM – L2 – Q118 – Working Capital Management

Assess if AquaPure Ltd is overtrading using financial data and compute relevant ratios.

AquaPure Ltd is a leading producer of mineral water in Zamora. The company sells all of its output to wholesalers on credit terms net 40. The company’s collection policy is somewhat relax, and so the receivables turnover days is currently 53 days. This fairly liberal credit policy has resulted in significant increases in sales revenue in recent years. However, the company has been facing cash flow problems as a significant number of customers take longer than the credit period to settle their accounts. The company typically falls on overdraft facilities from its bankers when it fails to generate adequate cash flows from operations to meet working capital requirements. The average cost of the overdraft facilities is 15% per annum.

Last week, the management team met and discussed the company’s cash flow and liquidity problems with a view to finding solutions to the problems. In that meeting, two proposals were offered to help solve the problems:
Proposal 1: Introduce early settlement discount of 1.5% on accounts that are settled within 10 days in which invoice is sent while the current credit period is maintained. It is estimated that 60% of accounts will be paid within the discount period.
Proposal 2: Switch from financing working capital requirements using the bank overdraft facilities at 15% interest to financing working capital requirements using supplier’s trade credit. Suppliers are willing to supply on credit terms 1/10, net 40. Proponents of the proposals believe that the implementation of their proposal will improve on the company’s financial situation.

Set out below are the company’s statement of profit or loss and statement of financial position for the past three years:

Statement of profit or loss for the year ended 31st December

20X5 (GH¢’000) 20X6 (GH¢’000) 20X7 (GH¢’000)
Revenue 40,000 60,000 122,000
Cost of sales (15,000) (31,000) (58,000)
Gross profit 25,000 29,000 64,000
Selling and administrative expenses (11,000) (17,500) (24,000)
Operating profit 14,000 11,500 40,000

Statement of financial position as at 31st December

20X5 (GH¢’000) 20X6 (GH¢’000) 20X7 (GH¢’000)
Noncurrent assets:
Property, plant and equipment 13,400 19,000 22,500
Current assets:
Inventory 8,000 15,500 25,500
Trade receivables 6,900 11,210 24,210
Cash 1,110 – –
Total current assets 16,010 26,710 49,710
Total assets 29,410 45,710 72,210
Equity:
Stated capital 100 100 100
Income surplus 18,510 28,110 36,810
Shareholders’ equity 18,610 28,210 36,910
Non-current liabilities:
Medium-term loan 3,000 2,500 2,000
Current liabilities:
Trade payables 2,200 3,500 8,600
Dividend payable 5,600 6,400 7,500
Bank overdraft – 5,100 17,200
Total current liabilities 7,800 15,000 33,300
Total liabilities 10,800 17,500 35,300
Total equity and liabilities 29,410 45,710 72,210

Required:
(a) Considering the background information and financial data provided above, would you conclude that AquaPure Ltd is experiencing overtrading? Explain with relevant computations.

(b) Appraise the proposal for early settlement discount (i.e. Proposal 1) and advise on whether it should be accepted for implementation or not. Your appraisal should focus on how the discount policy will influence the company’s profitability. Show all relevant computations.

(c) Appraise the proposal to switch from financing working capital needs using bank overdraft to using suppliers’ trade credit, and advise management accordingly. Show all relevant computations.

(d) Assuming AquaPure Ltd cannot raise additional funds from external sources such as borrowing and new share offer, suggest to management three steps they can take to ease the cash shortages the company is facing.

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  • 15 Marks

FM – L2 – Q34 – Dividend policy

Analyze dividend policy of Kumasi Freight Plc from 20X1-20X5 and estimate share price under four dividend options.

Question Tags: Dividend policy, Share valuation, Earnings retention, Shareholder returns, Financial strategy
Question Short Summary: Analyze dividend policy of Kumasi Freight Plc from 20X1-20X5 and estimate share price under four dividend options.

———————————————————–
Question:
The table below shows earnings and dividends for Kumasi Freight Plc over the past five years.

Year Net earnings per share Dividend per share
GH¢ GH¢
20X1 1.40 0.84
20X2 1.35 0.88
20X3 1.35 0.90
20X4 1.30 0.95
20X5 1.25 1.00

There are 10,000,000 shares issued and the majority of these shares are owned by private investors. There is no debt in the capital structure.
It is clear from the table that the company has experienced difficult trading conditions over the past few years. In the current year, net earnings are likely to be GH¢10 million, which will be just sufficient to pay a maintained dividend of GH¢1 per share.
Members of the board are considering a number of strategies for the company, some of which will have an impact on the company’s future dividend policy.
The company’s shareholders require a return of 15% on their investment.
Four options are being considered, as follows:
(1) Pay out all earnings as dividends.
(2) Pay a reduced dividend of 50% of earnings and retain the remaining 50% for future investment.
(3) Pay a reduced dividend of 25% of earnings and retain the remaining 75% for future investment.
(4) Retain all earnings for an aggressive expansion programme and pay no dividend at all.
The directors cannot agree on any of the four options discussed so far. Some of them prefer option (1) because they believe to do anything else would have an adverse impact on the share price. Others favour either option (2) or option (3) because the company has identified some good investment opportunities and they believe one of these options would be in the best long-term interests of shareholders. An adventurous minority favours option (4) and thinks this will allow the company to take over a small competitor.

Required:
(a) Comment on the company’s dividend policy between 20X1 and 20X5 and on its possible consequences for earnings.
(b) Advise the directors of the share price for Kumasi Freight Plc which might be expected immediately following the announcement of their decision if they pursued each of the four options, using an appropriate valuation model. You should also show what percentage of total return is provided by dividend and capital gain in each case. You should ignore taxation for this part of the question. Make (and indicate) any realistic assumptions you think necessary to answer this question.

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  • 10 Marks

FM – L2 – Q33 – Dividend policy

Suggest share price for Kumasi Transport PLC based on 25% dividend payout using dividend growth model.

he directors of an all-equity company are considering the company’s policy on dividends and retentions. The cost of capital is 9% and the company is able to invest in new capital projects that will earn this return. The company’s shares are quoted and traded on a major stock market.

In the year just ended, the earnings per share were GH¢2.00 per share. The company pays a dividend annually, and is about to pay a dividend for the year just ended on the basis of its selected dividend and retentions policy.

Required:

Suggest what the company’s share price might be if the directors select a policy of paying annual dividends that are equal to:

(a) 25% of earnings

(b) 50% of earnings

(c) 70% of earnings

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  • 6 Marks

FM – L2 – Q9 – Financial Policy Decisions

Discuss investment, financing, and dividend policy decisions, their interrelation, and impact on firm value.

When determining the financial objectives of a company, it is necessary to take three types of policy decision into account: investment policy, financing policy, and dividend policy.

Required:

Discuss the nature of these THREE types of decisions, commenting on how they are inter-related and how they might affect the value of the firm (that is the present value of projected cash flows).

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