Dividends

Question 1

Experiencing cash flow problems but paid dividend

Answer 1

• Bird in hand theory. Shareholders prefer dividends now compared to uncertain future growth
• Paying a dividend will jeopardize future growth and sustainability of company
• Directors hope that a continuous dividend payout will send a signal to market to support share price
• Share price might fall in response to dividend
• Investors require low volatility so they won’t be happy with additional risk
• If business risk is high, don’t pay dividend
• D:E is high, don’t pay dividend
• Violation of Co Act if insolvent and declare a dividend
• Loan covenants could be breached if you pay a dividend

Question 2

Argument for declaring a dividends

Answer 2

• The objective should be to increase SH/H wealth when paying out dividend, increase share price
• Many shareholders want certainty, bird in hand theory, rather have one bird in the hand than two in the bush
• A payment of dividends mean management is optimistic about future earnings
• Consider needs and expectations of SH/H others prefer growth others a constant dividend
• *JUNE EXAM**
• Dividend has a strong signalling element due to its cash nature (1), but this is generally to emphasize that profits are sustainable as they can choose, and will therefore commit (1), or that any losses are short term (1). That is not the case here, the company is in a lot of trouble, and a dividend signal will not rescue them from where they currently are
• The annual financial statements have limited value, historic in nature, fair value limits, accounting policy limits etc. (1) complexity of AFS for non-financial user, can be manipulated. (1)
• Instead of a positive, shareholders may see this as a failure of management, instead of saving the company but investing, they are just returning the funds.
• With a looming recapitalisation, a dilution is a real threat to all of these shareholders.
• Should also consider the tax impacts of the withholding tax (1), whereas shareholders are likely to have a deductible loss if they sell their shares (1)

Question 3

Consider before paying a dividend

Answer 3

• Consider dividend policy of the company
• Clientele effect before deciding on amount
• Consider other investment decisions
• Pay a dividend, reduce equity and increase financial risk
• Consider solvency and liquidity of Company
• Consider STC when declaring a large dividend

Question 4

Why a share Buy back?

Good and bad?

Answer 4

Good

• Signals that share price is undervalued
• Management needs to determine timing
• Share buyback will improve ROE
• More tax efficient
• Provides an opportunity to introduce leverage
• Individual SH/H can elect to participate or not
• A buyback does however provide flexibility, and can be done at any time
• A share buyback may however create backlash from all stakeholders, how do loans that may not be repaid, and creditors risking losing their money (1), and employees about to lose their jobs (1), feel about the company rather buying back their own shares

Bad

• BEEE SH/H sell, reduce credentials
• May be perceived as being negative as management failed to use cash to generate value
• Senior managers may benefit at expense of shareholders

-Negative impact on the capital structure, as the company is already over geared

Question 5

Cash or shares?

Answer 5

• Consider rand equivalent of shares to cash
• Is share offer currently higher than cash offer?
• Perform acquirer valuation post acquisition of value is more then it is attractive
• Consider the volatility of share price
• Are there expected synergies post acquisition?
• Is dividend policy of OR and EE different?
• Consider different shareholders and preferences
• Consider WHT on dividends
• Consider income tax and CGT
• Impact of gearing post acquisition
• Cash offer represents certainty
• Can restricted shares be sold privately?