Question

Good day, I trust you are well. Kindly assist with below...

The company is an online retailer of books, CDs and DVDs. The company was set up five years ago by a wealthy entrepreneur, David Nile, and has now grown to the point where the board of directors have decided that a listing should be sought on the local stock exchange. David Nile owns 80% of the ordinary shares and has agreed to sell all of these as part of the public offering.

Recently, the board of directors began to debate the future dividend policy of the company, assuming the stock exchange listing would be successful. However, there was a clear divergence of views. The chairman felt that the current dividend policy was unacceptable and needed to be changed. He argued that the company had been investing heavily in its distribution methods and in advertising in the early years and that dividend policy had not been a pressing issue. However, the proposed listing must now lead to a reconsideration of the importance of dividends. The chief operating officer, on the other hand, felt that the chairman’s concerns were unfounded as the pattern of dividends had no effect on the shareholder wealth.

Information concerning the company since it was first set up is as follows:

Year ended 30 November	Net profits after taxation	Ordinary dividends	Ordinary shares in issue
	R	R	R
2014	650	320	800
2015	520	150	1 000
2016	760	480	1 000
2017	1 240	600	1 500
2018	1 450	540	1 500

3.1 Evaluate the views expressed by the chief operating officer and by the Chairman. (12)

3.2 Analyse the dividend policy that has been pursued to date and discuss whether a change would be in the interests of shareholders. (8)

3.3 Discuss the key points that should be considered when establishing an appropriate dividend policy for the company. (5)

Answer 1

3.1]

The Chairman's views appear to be correct. Dividends were not a pressing issue in the initial years. However, with public listing of shares, dividends become an important issue

The COO's views are correct in theory - that dividends have no effect on shareholder wealth. However in reality, dividends are important to shareholders because dividends signal the prospects of the company and give some return to shareholders apart from capital appreciation

3.2]

It appears that no dividend policy has been followed so far - the pattern of dividends seems quite random.

A change would be in the interest of shareholders because a stable dividend policy indicates stability and growth for a company. The shareholders would benefit from a stable, growing company

3.3]

The key points to consider are :

• Keep enough earnings to reinvest in the company
• It should not be too high, so that in case of a bad year the dividend cannot be paid.
• Keep the dividend stable, and increase it only when there is confidence that the increased dividend can be paid year after year