QUESTIONS ON DIVIDEND POLICIES


A comparative study of the records of two oil companies, A Ltd and B Ltd., in terms of their asset composition, capital structure and profitability shows that they have been very similar for the past five years. The only significant difference between the two firms is their dividend policy. A Ltd. maintains a constant dividend per share while B Ltd maintains a constant dividend pay-out ratio. Relevant data is as follows:

Year

Earnings per share

 

Shs.

Dividend per share

 

Shs.

Price range

in stock exchange

Shs.

Earnings per share

 

Shs.

Dividend per share

 

Shs.

Price range

in stock exchange

Shs.

1996

1997

1998

1999

2000

1.89

1.50

2.00

2.60

3.90

0.45

0.45

0.45

0.45

0.45

16 – 18

12 – 15

14 – 20

21 – 26

26 – 40

2.05

1.45

2.07

2.55

4.08

0.35

0.25

0.36

0.45

0.69

11 – 15

6 - 14

7 - 16

15 – 23

21 – 44

Required

a) For each company, determine the dividend pay-out ratio and the price earnings ratio for each of the five years. (12 marks)

b) B Ltd’s management is surprised that the shares of this company have not performed as well as A Ltd.’s in the stock exchange. What explanation would you offer for this state of affairs? (4 marks)

 Comment on the applicability of the Simple Price/Earnings (P/E) ratio to the typical technology (IT) company with a high valuation and heavy losses.

(4 marks)

QUESTION TWO

a) In relation to the financing of a firm, differentiate the following terms:

 i) Financial structure from capital structure. (5 marks)

ii) Business risk from financial risk. (5 marks)

 b) What is meant by gearing as used in the capital structure of Limited Liability Company? (2 marks)

 The following information is on a company in the power generation business:

 

10% preference shares (Sh.10 par)

Ordinary share capital (Sh.10 par)

 

Retained profits

 

15% debentures

Shs.

400,000

400,000

800,000

700,000

1,500,000

1,200,000

2,700,000

  Required

i) Calculate the gearing ratio for the above company. (2 marks)

 ii) If the company’s net profit (before interest and tax) is Sh.2,000,000,000 and assuming a dividend payout ratio of 60% of the earnings, compute the dividend per share (DPS). (6 marks)

iii) If the market price per share now is Sh.80, compute the dividend yield.

(2 marks)

(Total: 22 marks)

QUESTION THREE

Explain the reasons why firms in the same industry with equal earnings and share capital would pay different amount of dividends?