Advanced financial management revision question and answer

Advanced Financial Management Block Revision Mock Exams

Summarised financial data for TYR plc is shown below:

(a) Explain, with supporting evidence, the current dividend policy of TYR plc, and briefly discuss whether or not this appears to be successful.

(b) Identify and consider additional information that might assist the managers of TYR in assessing whether the dividend policy has been successful.

(c) Evaluate whether or not the company‟s share price at the end of 2001 was what might have been expected from the Dividend Growth Model. Briefly discuss the validity of your findings.
(a) Estimates of earnings and dividends per share, and their growth rates are shown below:

From the above data TYR appears to be following a policy of paying a constant dividend per share, adjusted for the current year‟s level of inflation.
The only possible indication from the data of whether or not the dividend policy has been successful is the relative performance of TYR‟s share price in comparison to the market index. This, however, would rely upon the assumption that the choice of dividend policy influences the share price.

TYR‟s share price has increased over the four-year period an annual compound rate of 5.6%, much better than the annual fall of 5.5% suffered the all-share index. This does not prove that the dividend policy has been successful. The share price might be influenced many other factors, especially the potential long-term cash flow expectations of the shareholders. Additionally comparison with the all- share index does not measure the performance of TYR relative to companies in its own industry sector.

(b) Additional information might include:
Direct feedback from shareholders, especially institutional shareholders, stating whether or not they are happy with the current dividend policy.

Full details of the registered shareholders, and size of holdings. TYR plc might have a desired spread of shareholders, which could be influenced the dividend policy adopted.

Knowledge of the impact of taxation of dividends on shareholders‟ attitudes, and specifically on their preferences between dividends and capital gains.

The amount of capital investment the company wishes to undertake. The use of retained earnings and other internally generated funds avoids issue costs and the information asymmetry problems of

external financing. The level of dividends paid affects the amount of internal funds that are available for investment.

The impact of dividends on corporate liquidity.

The signals provided dividend payments about the future financial health of the company. For example, would the fact the dividend growth is lagging behind earnings growth be considered a positive or negative signal?

where D1 is the expected net dividend, ke is the cost of capital and g the growth rate in dividends. Using the average compound growth of 3.7%:
The actual share price at the end of 2001 appears to be overvalued relative to the dividend growth model.

This does not prove that the actual market price was overvalued. The dividend growth model relies upon restrictive assumptions, such as constant growth in dividends per share, which is unlikely to occur. There are also several factors that influence share prices that are not included within the model. Growth in earnings per share has increased more than growth in dividend per share, and it might be better to use the earnings growth rate in the model as this might more accurately reflect the financial health of the company.

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