Question

A plc is a medium sized listed company. The results for 5 years to 31 December 2019 are as follows:

	2019	2018	2017	2016	2015
EPS (cents)	140	136	131	127	122
DPS (cents)	82	81	79	78	77

Dividends are paid on 31 December each year and the dividend shown as declared in a particular year would have been or will be paid on 31 December the following year. If the current dividend policy is maintained, the directors estimate that annual growth in earnings and dividends will no better than the average growth in earnings over the past four years.

X plc does not consider to take on debt at the present time to finance growth. The company is 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 is currently quoted at 1.5 and is not expected to change for the near future.

Required:

1. Calculate the share price which might be expected by the market

1. If the company does not announce a change in dividend policy
2. If the company does announce a change in dividend policy using whatever model you think appropriate.

1. Comment on the limitations of the models you have used. (Word limit: 100 words).
2. Discuss the reasons why the share price might react differently from the market’s expectations. (Word limit: 100 words).

Answer 1

To determine the price of the share we will need to use the GORDAN MODEL to find the price of Share

Gordan Model:

Price of Share = Value of Next Year Devidend/(Expected Rate of Return - Growth Rate in Dividend)

So, if the company does not announce change in dividend policy it will continue to give existing dividends, The company is presently giving 58% of its earning as dividen which has been computed by last year data provided.

So the Answer to a(i)

Value of Next Year Dividend : 83 Cents, based on past year company performance.

Expected rate of return: 10% (Risk Free Rate i.e 6% + Market Risk Premium i.e 4%)

Growth Rate in Dividend: The Company growth rate which is equivalent to 3% based on last year data

So the Share Price will be = 83Cents/(10% - 3%)

= 1185 Cents equivalent to $11.85

So the Answer to a(ii)

Value of Next Year Dividend : 52 Cents, based on only 50% payout.

Expected rate of return: 10% (Risk Free Rate i.e 6% + Market Risk Premium i.e 4%)

Growth Rate in Dividend: The Company growth rate which is equivalent to 3% based on last year data

So the Share Price will be = 52Cents/(10% - 3%)

= 742 Cents equivalent to $7.42

Answer to B(i)

Limitation of Gordan Policy:

Constant Growth Rate of Dividend, which it not feasible for any comapny. Since the company changes its decision every year, to follow same policy for dividend is not possible for any company.

Answer to B(ii)

There Are many reason for price react diffrently from market expextation major mentioned below

1) Inflation

2) Change in Country Lending Policy

3) Any new rule implemented by Governemnt which is adverse for the Company

4) Economic Strenght of the Market

5) Unexpected Major Supply or Demand of the shares