Tesford plc has estimated net cash flows from operations (after interest and tax
ID: 2763376 • Letter: T
Question
Tesford plc has estimated net cash flows from operations (after interest and taxation) for the next five years as follows:
£ 5,000,000
The cash flows have been calculated before the deduction of additional investment in fixed capital and working capital.
This amounts to £2m in each of the first two years and £3m for each year thereafter. The firm currently has a cash balance of £500,000 which
it intends to maintain to cope with unexpected events. There are 24 million shares in issue. The directors are committed to shareholder wealth maximisation.
A. Calculate the annual cash flow available for dividend payments and the dividend per share is the residual dividend policy was strictly adhered to.
B. If the directors chose to have a smooth dividend policy based on the maintainable regular dividend what would you suggest the dividends in each year should be?
Include in your consideration the possibility of a special dividend or share repurchase.
C. Explain why companies tent to follow the policy in B rather than A.
Year Cashflow 1 £ 3,000,000 2 £ 12,000,000 3 £ 5,000,000 4 £ 6,000,000 5£ 5,000,000
Explanation / Answer
Annual Cashflows available for dividend payout will simply equal net cash flow from operations minus investments in fixed and working capital. The amount on a per year basis equals 1, 10 , 2 , 3 & 2 million pounds. Given that there are 24 million shares outstanding this leads to a dividend payment of 4.16 / 4.16 / 8.33 / 12.5 / 8.33 pence per share. To create a smooth dividend policy the directors should suggest a dividend of 4.16 pence per share every year. This strategy is preferred over the first option as it shows predictability in cash flow payouts and investors tend to value stocks that pay predictable dividends over those where dividend payouts are more voltile and unnecessarily sway expectations after a good year of results
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