Instructions
1. Answer all problems:
problem 1
a) Managing directors of three profitable listed companies discussed their companies’ dividend policies at the business lunch.
Company A; has deliberately paid no dividends for the last five years.
Company B; always pays a dividend of 50% of earnings after taxation.
Company C; maintains a low but constant dividend per share (after adjusting for general price index), and offers regular scrip issues and shareholder concessions.
Every managing director is convinced that his company’s policy is maximizing shareholders wealth.
Required
describe the advantages and disadvantages of alternative dividend policies of the three companies? Discuss the situation under which every managing director may be correct in his belief that his company’s dividend policy is maximizing shareholders wealth. Declare clearly any assumptions you make.
b) Discuss briefly five sources of external finance which a medium-sized company may use to finance its export sales.
problem 2
The management of Nelson plc wish to estimate their firm’s equity beta. Nelson has had a stock market quotation for only two months and the financial management feels that it will be unsuitable to estimate beta from actual share price behaviour over such a short period. Instead it is proposed to ascertain, and where essential adjust, the observed equity betas of other companies operating in the similar industry, and with the same operating characteristics as Nelson, as these must be based on same levels of systematic risk and be capable of providing an accurate estimate of Nelson’s beta
Three companies have been identified as firms having operations in the same industry as Nelson with identical operating characteristics. Though, only one company, Oak plc, operates exclusively in the similar industry as Nelson. The other two companies have some dissimilar activities or opportunities in additional to those which are the same as those of Nelson.
Details of the three companies are as follows;
a. Oak plc has an observed equity beta of 1.12. The capital structure at market value is 60% equity, 40% debt.
b. Beech plc has an observed equity beta of 1.11. It is estimated that 30% of the present market value of Beech is caused by risky growth opportunities that have an estimated beta of 1.9. The growth opportunities are reflected in the observed beta. Beech’s other activities are the same as Nelson’s. Beech is financed entirely by equity.
c. Pine plc has an observed equity beta of 1.14. Pine has two divisions, East and West. East’s operating characteristics are considered to be identical to those of Nelson. The operating characteristics of West are considered to be 50% more risky than those of East. In terms of financial valuation East is estimated as being twice as valuable as west. The capital structure of Pine at market values is 75% debt, 25% debt.
Nelson is financed by equity. The tax rate is 40%.
Required
a. Suppose all debt is virtually risk-free, make three estimate of the equity beta of Nelson plc. The three estimates should be based, separately, on the information provided for Oak, Beech and Pine.
b. Describe why the estimated beta of Nelson, when eventually determined from observed share price movements, may differ from the value derived from the approach in (a) above.
c. State the reason why a company has a very volatile share price and is generally considered to be extremely risky could have a lower beta value, and hence lower financial risk, than an equally geared firm whose share price is much less volatile.