MU-MAIN CAMPUS CPA (T) REVIEWS

Topic Six: DIVIDEND POLICY.

QUESTION 1: NBAA May 2022

There are conflicting views regarding the impact of dividend decisions on shareholders’ wealth
and the value of the firm. The question is whether the firm should pay out cash now or retain
profits for reinvesting.
Required:
(i) Explain Modigliani and Miller’s (MM’s) dividend irrelevant hypothesis. (5 marks)
(ii) Discuss the idea that dividends should be treated as a residual. (5 marks)

QUESTION 2: NBAA Nov 2021

Kericho Co. is a company listed on the local stock exchange. Currently, the company has
400,000,000 outstanding shares which are selling at TZS.16,000 each. The company is
contemplating paying TZS.1,600 cash dividends per share or to repurchase its own shares in place
of the cash dividend.
Required:
(i) Assuming that share repurchase will have no other signalling effect, compute the number
of shares to be repurchased and the new share price after the repurchase. (3 marks)
(ii) Briefly explain the wealth effect of share repurchase to the shareholders. (2 marks)

QUESTION 3: NBAA May 2021

(a) Dividend policy guides the division of earnings attributable to equity holders into dividend
payout and retained earnings. A firm’s dividend policy determines how much cash it will distribute
to its shareholders and when these distributions will be made.
Required:
(i) Evaluate the arguments for and against the relevance of a company’s dividend policy.
(6 marks)
(ii) Briefly explain any three (3) factors that determine a company’s dividend policy.
(6 marks)

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(b) Mafanikio Ltd is listed in the enterprise growth market section of the local stock exchange. The
results for 31st December 2020 have just been announced. Earnings Per Share (EPS) and declared
Dividends Per Share (DPS) for the last five years are shown below:
2020 2019 2018 2017 2016
EPS (TZS.) 700 680 655 635 610
DPS(TZS.) 410 405 395 390 385
Dividends are paid on 31st December each year and the dividend shown as declared in a particular
year will be paid on 31st December the following year.
If the current dividend policy is maintained, the directors of Mafanikio Ltd estimate that annual
growth in earnings and dividends will be no better than the average growth in earnings over the
past four years. Mafanikio Ltd is reluctant to take on debt at the present time to finance growth.
The company is therefore considering a change in its dividend policy and total investment
programme to allow 50% of its earnings to be retained for identified capital investment projects
which are estimated to have an average post-tax return of 15%. The market risk premium is
expected to be 4% over the risk-free rate of 6%. The company’s beta is currently estimated at 1.5
and it is not expected to change in the foreseeable future.
Required:
(i) Using the Capital Assets Pricing Model (CAPM) and/or dividend discount model, calculate
the share price which might be expected by the market if the company:
1. Does not announce a change in dividend policy. (3 marks)
2. Announces a change in dividend policy. (3 marks)
(i) Comment on the limitations of the models you have used in part (i). above. (2 marks)
(Total: 20 marks)

QUESTION 4: NBAA Nov 2019 (Final)

(a) A shareholder of Kimondobay Co. is concerned about the recent performance of the company
and has collected the following information:
Year to 31st December 2018 2017 2016
Turnover (TZS.) million 680 680 660
Earnings per share (TZS.) 58.9 64.2 61.7
Dividend per share (TZS.) 40.0 38.5 37.0

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Closing ex-dividend share price (TZS.) 648 835 740

Return on equity predicted by CAPM 8% 12%
One of the items discussed at a recent board meeting of Kimondobay Co was the dividend payment
for 2019. The Finance Director proposed that to conserve cash within the company, no dividend
would be paid in 2019, 2020 and 2021. It was expected that improved economic conditions at the
end of these three years would make it possible to pay a dividend of TZS.70 per share in 2022.
The Finance Director expects that an annual dividend increase of 3% per year in subsequent years
could be maintained. The current cost of equity of Kimondobay Co. is 10% per year. Assume that
dividends are paid at the end of each year.
Required:
(i) Calculate the dividend yield, capital gain and total shareholder return for 2017 and 2018,
and briefly discuss your findings with respect to the returns predicted by the Capital Asset
Pricing Model (CAPM) and the other financial information provided. (10 marks)
(ii) Calculate and comment on the share price of Kimondobay Co using the dividend growth
model in the following circumstances; based on the historical information provided and
based on if the proposed change in dividend policy is implemented. (5 marks)
(b) Discuss the relationship between investment decisions, dividend decisions and financing
decisions in the context of financial management, illustrating your discussion with examples where
appropriate. (5 marks)
(Total: 20 marks)

QUESTION 5: NBAA Nov 2019

Chukwani Company Ltd is thinking of revisiting its dividend policy. The objective of the
company’s dividend policy had been always to maximize the value of the company’s shares. The
company has made TZS16,000,000 of earnings in the current year. These earnings are expected to
remain constant in the foreseeable future. The company’s capital structure contains no debt and
shareholders require a rate of return of 16%.
The directors are thinking of three alternative policies. The alternative policies and their possible
impacts on the growth of the company’s earnings and dividends are shown in the table below:
Dividend Policy No. Description Expected Growth Rate in Earnings and Dividends
1 Retain 25% 7%

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2 Retain 15% 5%
3 Retain 10% 3%
Required:
Determine which option will maximize the value of the company’s shares and the total
shareholders’ wealth. Ignore taxation. (10 marks)

QUESTION 6: NBAA Nov 2018

The dividend growth model can be used in determining the cost of equity capital. This model,
however, has some weaknesses.
Required:
Outline weaknesses of the model. (6 marks)
NEM company has free cash flows of TZS.50 million and a total of 10 million outstanding shares.
Based on growth in revenue and reduction in costs, NEM expects the cash flow to grow by 10%
in the first two years, then 5% in the following three years. NEM further expects a constant growth
of 3% after five years. The weighted average cost of capital is 8%. Currently, the shares are traded
at TZS.100 per share.
Required:
(i) Using the Gordon Growth Model, what will be the current value of NEM? (3 marks)
(ii) Is this a good investment opportunity? Why? (2 marks)

QUESTION 7: NBAA Nov 2017 (Final)

In 2015, Dumisha Company paid dividends totalling TZS 3,600,000 on a net income of TZS 9
million. For the past 10 years, earnings have grown at a constant rate of 10 percent. However, in
2016 earnings were expected to jump to TZS 14.4 million and the firm was expected to have
profitable investment opportunities of TZS 8.4 million. It is predicted that Dumisha company will
not be able to maintain the 2016 level of earnings growth. The high 2016 earnings were attributable
to an exceptionally profitable new product line introduced in the year and the company will return
to its previous 10% growth rate. Dumisha’s target capital structure is 40 percent debt and 60
percent equity.
Required:
Calculate Dumisha’s total dividends for 2016, if it follows the following policies.

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(i) It continues the 2015 dividend payout ratio

(ii) It uses a pure residual dividend policy while maintaining its target capital structure

QUESTION 8: NBAA May 2017

(a) Amazon Company Ltd. and Zodiac Company Ltd, are in the same risk class. Shareholders
expect Amazon to pay a TZS.400 per share dividend next year when the stock will sell for
TZS.2,000 per share. Zodiac Co. has a no-dividends policy. Currently, Zodiac stock is selling for
TZS.2,000 per share. Zodiac shareholders expect a TZS.400 capital gain over the next year.
Capital gains are not taxed, but dividends are taxed at 25 percent.
Required:
(i) What is the current price of Amazon stock? (4 marks)
(ii) If capital gains are also taxed at 25 percent, what is the price of Amazon stock? (3 marks)
(iii) Explain the result you found in part (b) (ii) above. (2 marks)

(b) The net income of GGM Corporation, which has 10,000 outstanding shares and a 100%
dividend payout policy, is TZS.32,000. The expected value of the firm one year hence is
TZS.1,545,600. The appropriate discount rate for Magita is 12 percent.
Required:
(i) What is the current value of the firm? (2 marks)
(ii) What is the ex-dividend price of Magita’s stock if the board follows its current policy?
(3 marks)

Since the concept of Limited Liability Company was conceived, firms have been distributing
fractions of their earnings as dividends. Of recent, however, corporations are increasingly changing
their payout policy, and incorporating stock repurchase programs as a means of distributing
corporate cash flows
Required:
Explain the concept of share repurchase and briefly explain its advantages and disadvantages.
(6 marks)

Extract of the financing part of the statement of financial position of Keona Ltd is as follows

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TZS
Common stock (50,000 shares at TZS.3 par) 150,000
Paid-in-capital in excess of par 250,000
Retained earnings 450,000
Total shareholders’ equity 850,000

Keona Ltd is considering issuing an additional 5,000 shares of common stock as part of its stock
dividend plan. The current market price of Keona Ltd.’s common stock is TZS.20 per share.
Required:
Show how the proposed stock dividend would affect Keona’s stockholder’s equity. (6 marks)

QUESTION 9: NBAA Nov 2016

a. According to Modigliani and Miller's (M&M) theory, dividend policy is irrelevant in a world
of the frictionless capital market. How did miller and Modigliani arrive at this conclusion?
b. Discuss, using appropriate theories, any three determinants of dividend policy and decisions
in the real world.
c. Crane Ltd. Is listed on the local stock exchange. Currently, the company has 2 billion
outstanding shares selling at a market price of TZS.100 per share. The company has no
borrowing and has internal funds available to make a capital expenditure of TZS.30 billion.
The capital expenditure is expected to yield a positive net present value of TZS.20 billion. The
firm also wants to pay a dividend per share of TZS.15. Given the company’s capital structure
plan and its policy of zero borrowing, the company will have to issue new shares to finance
the payment of dividends to its shareholders.
Required:
With supporting computations, explain how Crane Ltd’s value will be affected.
(i) If it does not pay any dividend
(ii) If it pays the TZS.15 dividend

QUESTION 10: NBAA May 2016 (Final)

a. A company’s dividend decision has important implications for both its investment and its
financing decisions. In addition to paying cash dividends, there are several other ways in
which companies can reward their shareholders.

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Required:
i) Describe the alternative dividend policies that companies can adopt and their
significance.
ii) Discuss the dividend relevance and dividend irrelevance schools of thought.
iii) Explain any two alternatives other than cash dividends of rewarding shareholders.
b. Bolero Ltd could afford to pay a TZS.5 per share dividend annually forever. However, due to
the influence of one of the major shareholders, the company has resolved not to pay dividends
for the next 20 years. Thereafter it is expected that a TZS.30 per share dividend will be paid
indefinitely. The required rate of return for this company’s shareholders is 10% and it is
expected to remain so indefinitely.
Required:
i) Determine the current value of the share
ii) Determine the cost of the resolution not to pay dividends for the next 20 years for each
shareholder

QUESTION 11: NBAA May 2015

Shilo Designs Company is a small-sized manufacturing entity engaged in the manufacturing of
electrical parts. The firm has been following a policy of paying dividends every year. The shares
are listed on the stock exchange and currently command a price-earnings ratio p/e of 11.5
Other details
Earning of the company Shs. 500 million
Dividend Shs. 375 million
Number of equity shares 20,000,000@ shs 250 per share
Investment Shs. 5,000 million
Required:
By applying Walter’s dividend model
i. Determine the share price (5 marks)
ii. Establish whether the dividend/price ratio is optimal (5 mark)

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QUESTION 12:
Pay-all Inc., Payless Inc., and Pay-none Inc. have identical operations. They follow a large,
medium, and zero (no dividend) payout policy respectively. Pay-none Inc.’s shares currently trade
at $100 and are expected to trade at $125 in one year. The expected dividends per share (in one
year) for Pay-all and Payless are $25 and $12.50 respectively, and their ex-dividend stock prices
are expected to be $100 and $112.50 respectively. The market prices are set so that their after-tax
expected returns are equal. What should the current share prices of Payless Inc. and Pay-all Inc.
be? Assume that the marginal personal tax rate on dividends is 25%, and the effective tax rate on
capital gains is zero.

QUESTION 13:
The Sharpe Co. has a period 0 dividend of $1.25. Its target payout ratio is 40%. The period 1 EPS
is expected to be $4.5.
a. If the adjustment rate is 0.3 as defined in the Lintner model, what will be the Sharpe Co.
dividend in period 1?
b. If the adjustment rate is 0.6 instead, what is the dividend in period 1?

“Believe you can and you are halfway there”.

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