Question

Roads Ltd is a construction company that builds roads and related civil projects. The company recently faced increased calls from investors to pay dividends due to the perceived lack of new profitable projects in a low growth economy. The company has, in spite of weak business sentiment, maintained a stable profit margin. At a recent meeting, the board resolved to adopt a residual approach to dividend payments. You have been tasked with recommending the dividend that should be paid at the end of the 2018 financial year. The company expects to have earnings available to common shareholders of R 60 million and it will have five million shares in issue at the end of the financial year. Its project schedule for the next financial year is as follows: Project A B C D IRR 18% 15% 14% 11% Cost (Rm) 20 15 21 16 The company has a WACC of 8% and a target debt ratio of 60%. Required: Determine the amount of earnings available to common shareholders that could be paid out as a divided according to the residual policy. Create a brief report for the board showing the projects that would be undertaken and also determine the dividend that could be paid.

Answer 1

To The Board of Directors,

Roads Ltd.

Sub : Capital Projects investment for next year and Dividend payment as per residual policy

Dear Madam/Sirs,

As we are going through the review of or dividend distribution policy for 2018 end , we have gone through the potential investment projects for next year that need equity investment. We have 4 projects with IRR over WACC of 8% and we maintain the Debt Equity Ratio of 60:40 for the investment in the projects. The summary of the projecst and the Equity investments required are availble in the working below. After fulfilling the Equity investment needs , we will have R31.2M residual income available for the common stock holders . The EPS in the residual approach will be R6.24 per common share.

Submitted for your review of the working and approval of the residual dividend payout .

Yours sincerely

XYZ.

Working :

FY 2018:	Amount in Rm
Earnings Available for Common Shareholders	60
Project schedule for next financial Year	Project A	Project B	Project C	Project D	Total
IRR	18%	15%	14%	11%
Investment Required (Cost Rm)	20	15	21	16	72.00
Required Investment from Equity @40%(Rm)	8.00	6.00	8.40	6.40	28.80
WACC of Capital Investment =8%

As the IRR of all the Projects are above the cost of capital , all the projects should be accepted for investment.
The Equity Investment required for the projects=	28.80
Surplus Income available for Common Shareholders after meeting the Capital Investment needs=Rm	31.20
Common shares outstanding in million	5
EPS = (R )	6.24