Advanced financial management revision question and answer

Advanced Financial Management Block Revision Mock Exams

Assume all things are held constant other than the item in question, for each of the companies below:

A company with a large proportion of insider ownership all of whom are high-income individuals. A growth company with an abundance of good investment opportunities.
A company experiencing ordinary growth that has high liquidity and much unused borrowing capacity. A dividend paying company that experiences an unexpected drop in earnings from a trend. A company with volatile earnings and high business risk.

Required:
Explain whether or not you would expect each company to have a medium/high or a low dividend payment
ratio and the reasons for such categorization.
ANSWER
(b) (i) A firm with a large proportion of high income individuals will pay low or no dividends. Such shareholders prefer high capital to reduce their tax burden since capital gains in Kenya are tax exempt.

(ii) A growth company with abundance of good investment opportunities.
Such a firm would pay low and retain more profits to finance its good investment opportunities.

(iii) A company with ordinary growth and high liquidity.
Such a firm could pay high dividends and retain less. With high liquidity and much unused debt capacity, the firm can easily borrow debt capital to achieve optimal debt capital. It has access to capital markets.

(iv) A dividend paying company that experiences an unexpected drop in earnings from trend. Such a firm would pay medium dividends but if the drop in earnings persist in future it should adopt payment of low dividends.

(v) A company with volatile earnings an high business risk.
This firm should pay low dividends and retain more profits to finance its investments. With high business risk, the firm does not have access to capital markets and it is difficult to raise secure debt capital which would nevertheless increase the financial risk of the firm.

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