1. Dividend Policy Question: a) Discuss the similarities and differences between
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Question
1. Dividend Policy Question:
a) Discuss the similarities and differences between dividend payment and share repurchase. [8 Marks]
b) Describe the meaning of earnings management and comment on how earnings management may influence the level of dividend payment.
2. Corporate Mergers Question:
a) Describe the meaning of “operating” synergy. [5 Marks]
b) Provide an example of “financial” synergy and briefly explain how it can influence a firm’s value. [5 Marks]
c) In merger valuation, we often use the Adjusted Present Value (APV) method instead of the WACC method. Explain why.
Explanation / Answer
Answer 1)
a)
Dividend
Share Repurchase ( buyback)
Similarity
Dissimilarity
B)
Earnings are generally the profits at the end of financial year to a company. Investors consider earnings to decide the charisma of a particular stock. Generally Companies with poor earnings have lower share prices in market in comparison to those with good prospects. Earnings management is a complex and long term strategy used by the top management of a company to manipulate the company's profits to match with pre-determined target. This strategy is used for the purpose of income-smoothing. Thus, instead of having years of exceptionally good or bad earnings, try to keep the earning figures relatively stable by using cash from reserve accounts.
Such amount of profit and reserve creation directly impact the amount of dividend paid to shareholders. The company with high earning in a particular year force top managment to create more reserve for future rather thandistributing as dividend.
Answer 2)
A) Operating synergy is defined as the performance of new firm formed by combination of two existing firmis greater than the sum of the separate firms apart . this allow the new firm to increase their operating income and achieve higher growth. some important reasons of synergy is
B)
Financial Synergy, benefit achieved by the combining of companies, is often a driving force behind a merger.The type of synergy link to enhancement in the financial metric of a combined business such as revenue, debt capacity, cost of capital, profitability, etc.it can be created by
Such change is capital structure and cost of capital directly influence the value in market
C)
The adjusted present value is the NPV of a company, is calculation of the cost of financing by equity plus the present value (PV) of any other type of financing benefits, which may be additional effects of debt. APV includes tax shields such as those provided by deductible interest.
But WACC only explain the weighted average cost of capital of the firm , the other benefit or effect of capital cann't be the part of WACC.
That's why APV is a better use in merger valuation.
Dividend
Share Repurchase ( buyback)
Similarity
- distributed as part of the company’s after-tax profit
- paid to the existing shareholders
- strategy to improve market valuation of share
- transfer surplus cash sitting idle on the balance sheet to its shareholders
- repurchase from part of the company’s after-tax profit
- paid to existing shareholders ( as purchase price)
- strategy to improve market valuation of share by reduction in number of floating shares
- allow the company to transfer surplus cash sitting idle on the balance sheet to its shareholders
Dissimilarity
- No change in share holding pattern
- Generally share value decline after dividend payout
- change in share holding pattern
- prevents a decline in the value of a stock ,as less supply of share
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