Dividend Policy and Mergers and Takeovers

This project report covers the concept of dividend policy and strategies for mergers and acquisitions. It discusses factors influencing the size of the annual dividend, practical issues in deciding the dividend payment, the effect of different options on shareholder wealth, and the influence of investment opportunities on company decisions. It also includes calculations using the price/earnings ratio and dividend valuation method.

FINANCIAL MANGEMENT

Table of Contents
INTRODUCTION:..........................................................................................................................3
1. DIVIDEND POLICY...............................................................................................................4
1.1 The size of the annual dividend to return to its shareholders............................................4
1.2 Practical issues that need to be considered when deciding on the size of the dividend
payment........................................................................................................................................5
1.3 Effect of options on the wealth of shareholder.................................................................6
1.4 Critically discuss how company’s decision will be influenced by opportunity to invest
£70m in a project.........................................................................................................................8
2. MERGERS AND TAKEOVERS.............................................................................................9
2.1 Price/earnings ratio:..........................................................................................................9
2.2 Dividend valuation method................................................................................................10
2.2 Discounted cash flow method.........................................................................................11
2.3 Problems associated with using the above valuation techniques....................................11
CONCLUSION..............................................................................................................................15
REFERENCES..............................................................................................................................16

INTRODUCTION:
This project report consists of two question; first question will cover the concept of dividend
policy other question will cover strategies Mergers and acquisition concept. Report shows
various calculations such as calculation of dividend growth rate, identifying average growth
rate for determination of fair price value of the shares; impact of change in required rate of
return by shareholders on fair price of share is also analyzed. Second part calculation includes
number of issued share capital, ordinary to right issues share ratio and earnings per shares.
This report will cover how to calculate fair price through dividend growth model and what
problems faced by company in valuing shares through this model.
Project contains case study of two hypothetical companies; Squeezeco and Aztec; where first
company is looking for distribute dividend among its shareholders with having three
alternatives, report will show which option is best for company. On the other hand; second
company wants to takeover Trojan plc in near future; the main issue facing by Aztec is
deciding the value of takeover. For this various analyses like price earnings ratio, dividend
valuation and discounted cash flow has been done to support decision of the company.

1. DIVIDEND POLICY
1.1 The size of the annual dividend to return to its shareholders
A company’s dividend policy means mix of strategies for deciding how much
percentage of total earnings after tax has to be shared with outstanding dividend
shareholders. There are two types of shares issued by the company; preference shares
and equity shares, where preference shareholders are liability for the company because
they need to be paid fixed rate of dividend regardless of profit or loss to the company
and they don’t have decision powers in firm. On the other hand; equity holders are
decision makers but not liable to get fixed rate of return (Kadu and Oluoch, 2018).
Company pays off dividend to equity holders to maintain good relation and demand of
firm’s shares in the market. The main issue faces by Squeezeco is deciding the
proportion of annual dividend to be shared among equity holders. Some of the factors
to be considered while deciding annual dividend are discussed below:
1. Working capital required: Squeezeco needs to analyze how much working capital it
requires upcoming year. As working capital is necessary to run business and meet
day to day expenses of the company. So, best thing is to deduct future working
capital requirement from current years earning (Ottoo, 2018).
2. Future expansion plan: If company is looking for merger or takeover or opening
new factory; it requires some fund. Therefore in this case to attract more
shareholders at high market price, it could pay dividend at high payout ratio.
3. Matching with cost of debt: Under this factor; Squeenzeco can match the cost of
equity with cost of debt to decide how much dividend it should pay to shareholders.
For instance; for raising 50 million pound through at the rate of 7%; total cost of
debt for year will be 3.5 million pound. Hence; if company is raising same amount
though equity shares, then it should not pay more than 3.5 million to share holders.
4. Provision for unexpected events: Besides working capital requirement; the another
factor which company should be considered is any unexpected activity during year
such as instant increase in demand, strike, remuneration to government, urgent

repairing of building or plant and machineries, legal issues, etc. Firm’s requires
instant cash; hence after proper analysis of probability of occurring of this risk,
Squeenzeco has to deduct some portion of net earnings.
Above factors are not enough to decide dividend policy and find accurate
proportion to be share with shareholders by Squeenzeco; but analyses of these
points will support company in reach to near size of the annual dividend to return to
its shareholders.
1.2 Practical issues that need to be considered when deciding on the size
of the dividend payment
It’s not only the factors which effects the decision of senior managers for the size of
dividend to be return to shareholders. Practical issues are the problems face by
business while implementing dividend policy. Some of these practical issues have
been discussed below:
1. Choice of shareholders: The first issue is choice or preference of shareholders; as
all shareholders have different tastes and thoughts. Sometimes shareholders don’t
prefer dividend, rather they want company to invest these retained earnings on
acquiring new projects or expansion of existing business. As this step will
improve share price and simultaneously increase market price of share price,
which will benefits shareholders at the time of selling shares.
2. Different options: Business owner could give dividends in two forms; cash
dividend and scrip divided. Main issue face by the company is to decide which
option should be undertaken to satisfy shareholders by meeting their choices
between scrip dividend and cash dividend.
3. Shareholders expectation; It’s hard for company to predict shareholders
expectations for dividend price; as paying more than expected will be thought by
shareholders as company is not focusing on growth and will expect that share
price will down in future.

4. Owner of dividend: After bring shares of the company in open market, it basically
gone through many shareholders; the problem rise is identifying who is the real
owner of shares and whom to pay dividend. Thus to solve this issue firms
considered recorded date; shareholders has to registered himself as the real owner
on particular date given by share issuer firm (Schroeder, Clark and Cathey, 2019).
5. Regulations act: Regulatory authority has abided company with set of rules to be
followed by company without failure such as firm has to maintain a fixed
proportion of reserve according to dividend paid. For instance, if company has
paid 15% dividend then it has to maintain at least 7.5% retained earnings for
reserve.
1.3 Effect of options on the wealth of shareholder
I. A cash dividend payment of 15p per share:
i. Cash Dividend:
A Total shares outstanding 1,250
B Dividend price per share 15p
Total cash dividend(A × B) £187.5
Cash Dividend: These are cash revenues received by shareholders as a reward
for the risk taken by them investing in particular company. It is paid by the
company by transferring fund directly in the account of investors or issuing
cheque for the same amount (Ahmadi, 2017).
Interpretation: Total shares outstanding are 1250 which are liable to get
dividend; here the choice taken for payment of dividend is cash rewards. Hence;
total cash dividend at 15p per share holder is £187.5.
II. A 5% scrip dividend:
Scrip Dividend: A scrip dividend is an alternative to cash dividend, it is issued
by the company when firm has not enough cash left to pay its shareholders but to
maintain its goodwill; it still pay dividend to its investors in the form of new
shares. It is also known as liability dividend which is issued by company to

shareholders in the form of certificate; issuing scrip dividend is sometimes given
a choice to investors or issued by company when payment of cash dividend is
not possible (Bertsatos, Sakellaris and Tsionas, 2017).
ii
. 5% Scrip Dividend
A Total shares outstanding 1250
B Scrip divided (A × 5%) 62.5
C Share price 432p
Total dividend worth (B ×
C) £270
Interpretation: Here, total outstanding shares are 1250; proportion of 5% has
been taken from total shares as a scrip dividend which is 62.5. Given share price
is 432p per share; hence total dividend worth of dividend holder by getting new
shares are £270.
III. Repurchase of 15% of ordinary share capital at the current market price:
Repurchase of ordinary share capital means; company purchases back shares
from share holder at market price; where old price will always less than market
price. The benefit received by shareholder is difference between new price and
old share. Squeezeco use this strategy to bring back its ownership and benefit
dividend holders at same time.
Repurchase of 15% ordinary share capital at the current market price
Total ordinary shares 1250
A 15% of ordinary shares 187.5
B Current Share price 432p
C Previous share price 50p
D
Total Profit on each share
(B -C) 382p
Total shareholders worth
(A × D) £716
Interpretation: T he total shares outstanding is 1250 out of which at the rate of
15%, 187.5 shares has to be repurchase at current market price. Company’s old

price of share was 50p and current market price is 432p; hence the difference of
both which is 382p are the profit received by shareholders. The main advantage
of this strategy is; Squeezeco buy back its share and showing it has paid it in the
form of dividend which is smart step taken by firm.
Comparison:
After comparing all three methods it was found that maximum dividend value
which increases the wealth of shareholder is option iii; where company is
repurchasing its ordinary shares back. And lowest dividend is paid in first option
where company is paying off dividend through cash dividend.
1.4 Critically discuss how company’s decision will be influenced by
opportunity to invest £70m in a project
For investing 70 million pound; the first effect on decision will be selecting alternate
for raising fund for investment. There are three options available with owner of firm;
financing through debt, rising funds through issue of equity shares or utilize reserves
and surplus. These three options have own advantages and disadvantages. The best
strategy could be using mix of all these methods. For instance; firm can breakdown the
requirement of fund into three proportions like 30% through debt, 60% through issuing
equity shares and rest 10% through reserves. In case of issuing shares company has
further three options:
 Right issue of shares to existing equity holders.
 Issuing preference shares having fixed rate of dividend payment and;
 Issuing ordinary shares at reduced market price.

2. MERGERS AND TAKEOVERS
2.1 Price/earnings ratio:
Price-Earnings Ratio, also known as P / E Ratio, P / E or Per, is the ratio of the
company's share price per share of the company. Ratios are used to evaluate
companies and to find out if they are overvalued or undervalued. The share price
multiplied by the company profit per share (after tax) is called the price to
earnings ratio. Commonly known as the ratio per or bus ratio. Those with small
numerical values indicate that the stock price is relatively low relative to the
company's profits. It is used as a criterion for stock investing. Internationalization
of capital markets, increased awareness of economic growth, and similarly, the
importance of price-earnings ratios as indexes became important (Townsend, Neal
and Morgan, 2019).
P/E proportions are utilized by financial specialists and investigators to decide the
general estimation of an organization's offers in logical correlation. It can likewise
be utilized to think about an organization against its own verifiable record or to
look at total markets against each other or after some time.

Interpretation: The figure shows that Trojan plc, shareholders have earned 27p
per share. To get price earnings ratio or P/E ratio; total distributable net income
after deducting interest and tax is divided by total shares outstanding or shares
issue by the company. Here total net income of the company during year is 40.4
million pounds, and total outstanding shares are 147 million.
2.2 Dividend valuation method
This method uses required return as discounting rate to equal the dividend price
with shares price at present year. This method is also known as dividend
discounting model or DDM; it is used for estimating the price of Aztec shares on
the basis of time value of money. Where, all dividends are discounted back to
their present values to know its worth with reference of today. Calculation of
dividend valuation with the help of Dividend discount model is done below:
Dividend Discount Model Fair Value: £4.774
Expected Growth Rate = (1 – Dividend Payout Ratio) × Return on Equity
Expected Growth Rate = (1 – 0.48) × 0.27
Expected Growth Rate = 0.14
Expected Dividends Next Year = Dividends per Share × (1 + Expected Growth
Rate)
Expected Dividends Next Year = 0.13 × (1 + 0.14)
Expected Dividends Next Year = 0.148
Cost of Equity = Risk-Free Rate + Beta × Market Risk Premium
Cost of Equity = 0.05 + 1.1 × 0.11
Cost of Equity = 0.171
Fair Value = Expected Dividends Next Year / (Cost of Equity – Expected Growth
Rate)
Fair Value = 0.148 / (0.171 – 0.14)
Fair Value = 4.774
Interpretation: After calculation it was found that the calculated value of dividend
today is 4.774p per share. To calculate above equation; market share rate, free

float rate and equity beta plays major role; market rate also known as premium or
risk rate because this extra premium is taken over taking risk through investment.
While free float rates are not subject to risk because there will be no chance of
losing investment value.
2.2 Discounted cash flow method
This method helps in identifying net present value of the project with reference to
invested today and calculating future cash inflows as it is received today by
discounting values with inflation rate; here discounting factor is taken on the basis
of bond rate which is free float rate (Weetman, 2019).
Discounted cash flow method
Yea
r Net Income £m
Discounted
cash flow
@7%
1 £40.40 £37.76
2 £41.21 £35.99
3 £42.03 £34.31
4 £42.87 £32.71
5 £43.73 £31.18
£171.95
Interpretation: Hence on the basis of calculation of discounted cash flows of
distributable income with the annual growth rate of 2% per annum; it was found
that company will receive total cash of £171.95m (today value) at the end of 5
year.
2.3 Problems associated with using the above valuation techniques
Some of the problems associated with the use of above three methods are
discussed below:

 Precision required: It would be more appropriate to say that given the amount
of uncertainty and risk associated with greater dividend-earnings in the distant
future and the greater attachment of shareholders to immediate income from
dividends, Mr. Gordon also His dividend theory had to be changed later, as a
result of which his theory was actually dividend capitalization model (Pratt,
2016).
 Accurate forecasting is not possible: Changes are complete. The current style
is subject to change at any time. It is difficult to say when a new fashion will be
adopted by consumers and how long it will be accepted by buyers. If our
product is fashionable and popular, we can get the best results; And if our
products are not in accordance with fashion, sales will be affected. (Maynard,
2017).
The consumer's viewpoint may change at any time. Foreclosure may not be
able to predict consumers' behavior. Some market environments are early in
action. Even rumors can affect market variables. For example, when we use a
particular brand of soap, it can feel itchy on some people and if the news
spreads among the public, sales will be severely affected. (Hoggett and et. al.,
2018).

 High growth problem: No extravagant valuation model can take care of the
issue of high-development stocks. In the event that the organization's profit
development rate surpasses the normal return rate, you can't figure a worth
since you get a negative denominator in the recipe. Stocks don't have a
negative worth. Consider an organization with a profit developing at 20%
while the normal return rate is just 5%: in the denominator (r-g), you would
have - 15% (5% - 20%).
The improvement rate does not make the general return rate, advancement
stocks better, which do not benefit, this model being impressively difficult to
use. If you intend to advancement stock with a benefit discount model, your
valuation will only be founded on principles about the association's future
benefits and benefit technique decisions. Most advances do not express stock
gains. Consider Microsoft, which did not express a benefit for a serious long
time. Given this reality, the model may suggest that the association was
meaningless around that point - which is absolutely stupid. Remember, about
33% of each and open union expresses benefits. Furthermore, even the unions
that pay are appointing speculators less and less of their salaries (Carlon and et.
Al.., 2019).
 It is over simple model: The truth of the venture world is that the profits at an
organization won't develop at a particular rate until the finish of time. A few
organizations increment their profits after some time. Others may lessen their
profits. Some have even decided to dispose of them inside and out. These
activities are not part of the computation procedure of the valuation model.
That implies this model is best utilized on the couple of organizations which
reliably give a profit development rate every year.
 Only applicable to dividend paying shares: When contrasting little top
stocks with enormous top stocks, it is the littler organizations which have
performed better over long haul time spans. Most independent ventures are not
in a situation to deliver a profit, which implies this valuation model can't be
utilized to decide their worth. It must be utilized on stocks that do deliver a
profit. In the event that financial specialists concentrated distinctly on this

particular model, at that point they would possibly pass up on various chances
to increase the value of their portfolio (Stockenstrand and Nilsson, 2017).
Recommendation:
On the basis of calculations and limitations of above three methods; it is
recommended that Aztec should prefer Net present Value method to value Trojan
plc. The reason is, every business run on its yearly earnings and both the methods
have taken earnings as their base value; and other method ignores size of
investment and earnings which makes no difference between ordinary project and
big investments. Therefore discounting model is strongly recommended to use in
analyzing value of Trojan plc (Ahmadi, 2017).

CONCLUSION
After analyzing and evaluating both the cases of dividend policy and long term financing
equity, it is recommended that company should implement updated tools to calculate
accurate fair price of the share. Because in this project fair price of shares is calculated by
considering dividend growth model which has many problems with valuing shares; to
overcome this limitation company may apply multi stage dividend discount model; this
model will solve the problem of estimating price for unsteady dividends and it will help
in assuming close to accurate price through calculation of differing growth trends.

REFERENCES
Books and Journals