Assessment of Dividend Policy and Investment Appraisal Techniques

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Financial management

Table of Contents
1. Calculation of dividend policy.....................................................................................................3
a) Calculation of Fair value of plants share.................................................................................3
b) Plants new share price calculation...........................................................................................5
(C) Problems that arise in dividend policy in the valuation of shares.........................................6
2. Calculation of investment appraisal techniques..........................................................................7
References......................................................................................................................................11

Question 1
1. Calculation of dividend policy
Dividend policy is an instrument that is used by companies to share their part or revenues with
shareholders of the company. Shareholders are an important part of any company so when a
company gets from its operations than generally, a company has two options whether they share
their profit with shareholders or profit retained for future that is called retained earnings for a
company. It is a critical decision for any company whether they share or retained for future but if
a company share their part of the profit with shareholders than that create a positive impact on
goodwill of company which is useful for them because when further any capital required than
investors willingly invest in that company (Masum, 2014). Retained earnings are also an
important source to reduce future uncertainties when a company faces a cash crisis in the
company than they have only one option, use their retained earnings for future operations so it's a
critical decision for any company to take. A company uses different types of dividend policy to
distribute a dividend to shareholders, policies such as regular dividend policy, irregular dividend
policy, stable dividend policy, and no dividend policy. A company can distribute dividends
through cash dividend and issue bonus shares. In cash dividend policy a company simply pay a
dividend in cash to their shareholders which is reduce earning of the company in terms of cash
reserve. When revenue of a company is higher than usual than they issue some bonus share to
their shareholders with a cash dividend, in this case, a company pay a dividend in cash and also
issue bonus shares to shareholders without any further cost. The dividend policy of a company is
always creating an impact on the value of the company but a dividend policy must be made
according to the goals of the company and that dividend policy must maximize the wealth of
shareholders. A regular dividend policy is simply distributing their earnings to shareholders
every year, in this case when a company earns higher revenues than usual than they kept that
excess revenue as retained earnings. There is a positive aspect of this policy from an investor’s
aspect if a company face loss in their operations but still shareholders get their part of the
dividend. A regular dividend policy is less risky from an investor's perspective because, in any
scenario, an investor must get a dividend from the company (Hunjra et. al., 2014). The regular
dividend policy is used by those companies who have a stable cash flow system and earn stable
revenue from their operations. A stable dividend policy is providing a fixed amount of company

earnings to shareholders like – 10% every year. If a company earns higher than its usual profit in
that case a company only paid a fixed percentage to its shareholders. This kind of policy is useful
for those companies who have unstable earnings. In the irregular dividend policy, a company is
not liable to pay a dividend to its shareholders if a company earns higher revenue than it’s not
mandatory for a company to pay a dividend to its shareholders. If a company earns higher than
usual than its dependent on the board of directors of the company whether they pay a dividend to
shareholders or use earning as a source of business development. In this case, shareholders are
not liable to demand dividend from the company if a company pay dividend than its good and if
a company does not pay dividend than investor keep remain silent on the decision of the board of
directors of the company. The irregular dividend policy is framed by those companies who have
an unstable cash flow system. In the no dividend policy a company is not paying a dividend to its
shareholders in any case (Yegon et. al., 2014). If a company earn higher revenue than usual
earning than they use that profit for retained earnings or development of business and those
companies who use no dividend policy are growing faster than any other who use another
dividend policy. In this case, an investor invests in the company, not for dividend distribution but
shareholders want an to increase in prices of shares so that they can earn through overvalued
shares.
There are many decisions is taking by the board of directors of a company and dividend
distribution is a critical decision taken by the board of directors of a company. A company has
many obligations to do like – to pay a debt or reinvest in the company so it's important for a
company to keep remain balance between dividend and another financial aspect of the business
so for taking successful decisions for the company, the board of directors of the company should
think out of the box. There are a lot of factors that directly and indirectly affect the dividend
policy of a company.
 The stability of earnings is an important factor that directly affects the dividend policy of
the company. Companies that are usual in their earnings and earn stable earnings are
liable to pay more dividends because that is a financially strong company than an
unstable earning company.
 The dividend policy of a company is also dependent on the financing policy of the
company. If a company wants to pay their expenses through earning of company than

that company would pay less to their shareholders and if a company feel burden of debt
than that company must pay to their shareholders and use an internal source of financing
expenses so financing policy of a company is a crucial factor that create influence on
dividend policy of company.
 The dividend policy of a company should be made according to the competitor's dividend
policy. If a company is paying a higher dividend than investors must opt towards that
company so a company made its dividend policy according to competitors, they must
keep competitors in their minds while making dividend policy for the firm.
 The past dividend policy of the company is also creating a huge impact on the dividend
policy of a company. A company should approach a stable dividend policy that will
improve the goodwill of the firm in terms of the financial aspect of the business.
 Debt is an important factor that decides the rate of the divide if a company has more debt
than its better for that company to pay fewer dividends to shareholders. If a company is
completely debt free than that company should pay a higher dividend to its shareholders.
Debt is an important factor that every company should take concern about if the debt of a
company increases than might be debtors control activities of the company so it's better
for a company to keep remain debt low as possible.
 The dividend policy of a company is also dependent on the ability of the firm to generate
capital from the market. If a company has better goodwill in the market and that company
can easily procure capital from the market any time than that company should pay more
dividend to their shareholders because of better financial position of the company. If the
ability of a company to generate capital from market is not good enough that they must
pay less dividend to their shareholders because it’s important for that company to keep
retained earnings for future, when urgently capital required to company than its difficult
for that company to generate capital from market instead they use their retained earnings.
 The dividend policy of a company is also dependent on the growth rate of the company if
a company is already expanding its business and they don't need further expansion than
they can pay more dividends to their shareholders. A company is newly started and they
need to grow in the market further than its quite difficult for a company to pay more
dividends instead it's better for them to use retained earnings for their business expansion.

 The profitability of a firm is also deciding the dividend payout of a firm. If a firm is
getting enough profit to cover its expenses and business of that company is also
continuously growing than they can pay more dividends to its shareholders. If a company
is not getting enough profit to grow their business than its better for them to save revenue
and use it for further business development.
 The trade cycle also creates a big impact on dividend policy of a firm, if there is
deprecation condition in the market than the economy is on slow down than its better for
a company save their revenue for future expansion of the business.
 The business policies of a company also create a huge impact on the dividend policy of a
company if a company want to reduce the control of shareholders than that company
should pay less to their shareholders.
So these are some important factors that directly or indirectly effect on dividend policy of the
company.
a) Calculation of Fair value of plants share
YEAR DIVIDEND (£)
1 0.13
2 0.14
3 0.17
4 0.18
D1(CURRENT YEAR
DIVIDEND)= 0.2
K(SHAREHOLDER'S RATE OF
RETURN) 14
YEAR
DIVIDEND
GROWTH RATE
1 7.69%
2 21.43%

3 5.88%
4 11.11%
Average growth rate 11.53%
value of stock= (D1/k-g)
year value of stock
1 2.22
2 2.09
3 2.22
4 6.92
5 9.03
Value of stock:
P= D1/k-g
Wherein,
The p=the current price of the stock
D1= the expected next year’s dividend
K= the constant rate of equity
G= the growth rate of dividend
D1=
The fair price for planet’s share is £ 9.30

b) Plants new share price calculation
value of the
stock(D1/k-g)
Year Value
1 1.82
2 1.027
3 -2.82
4 1.89
5 5.76
The value of stock = D1/k-g (Woodruff, 2019)
The new price for Planet’ share is £ 5.76.

(C) Problems that arise in dividend policy in the valuation of shares
The dividend growth model is a measurement of the fair value of the stock, in the dividend
growth model it is assumed that the growth of dividends is either grow at a stable rate or grow at
a different rate. The dividend growth model is determined whether a stock is undervalued or
overvalued in the near future.
These are some limitations to the dividend growth model.
 The use of the dividend growth model is only limited, the dividend growth model is only
useful for those companies who already paying sufficient dividends to its shareholders
(Accounting-simplified, 2017.). In this case, if an investor wants to earn higher revenue
than it is not possible in this case.
 The dividend growth model is suffered from a lot of assumptions such as growth rate, tax
rates, and interest rates; it's not possible for an investor to control all these assumptions.
 The dividend growth model has also decreased the tax efficiency of an investor because
sometimes this model proper investors to repurchase shares.
 The dividend growth model is not useful for investors who hold large numbers of shares
in a company because they can create an influence of the dividend policy of a company
any time.
 The dividend growth model is not considered non-dividend factors of a company which
is important from a company perspective, factors such as customer retention, brand
loyalty and intangible asset ownership (Woodruff, 2019).
So these are some limitations of the dividend growth model which is faced by a company
and investors.

2. Calculation of investment appraisal techniques
When a business is investing in their operations or activities of business than its important for
that company to properly measure investment so that a company can save cost and only do
investment on those activities which is beneficial for the company (Locatelli et. al., 2016).
Investment appraisal techniques provide guidance to a company on how to measure the
successfulness of an investment. A company uses different methods to measure the performance
of investment methods such as payback period method, discounted cash flow method, rate of
return and risk of investment. Investment appraisal techniques are useful from a company
perspective because it increases the wealth of shareholders. Investment techniques are useful
from a company point of view because it increases the productivity of the company and it is also
helpful in increasing the market share of the company. Investment is always improving the
growth of business and if an investment is properly analyzed than that investment is always
creating an asset for the company.
Year
Investme
nt +
Salvage
Sales Expens
es
Net
Amount
DCF @
12% Amount
0 275,000 - - (275,000) 1.00
(275,00
0)
1 - 85,000 12,500 72,500 0.89 64,732
2 - 85,000 12,500 72,500 0.80 57,797
3 - 85,000 12,500 72,500 0.71 51,604
4 - 85,000 12,500 72,500 0.64 46,075
5 - 85,000 12,500 72,500 0.57 41,138
6 41,250 85,000 12,500 113,750 0.51 57,629
Total 43,976
Payback Period
Net amount till 5
years (13,654)

Term required in the
6th year 0.236923
In months 2.84308
Total Payback Period
5 years 3
months
NPV 43,976
Accounting Rate of
Return
Investment 275000
Year Salvage Sales Expens
es
Depreciati
on
Net
Amount
1 - 85,000 12,500 - 72,500
2 - 85,000 12,500 - 72,500
3 - 85,000 12,500 - 72,500
4 - 85,000 12,500 - 72,500
5 - 85,000 12,500 - 72,500
6 41,250 85,000 12,500 - 113,750
Total 476,250
Average 79,375
ARR 29%
Internal Rate of
Return
17.17%

The Payback Period is a period that is required to recover the initial investment from the cash
flows received over the years as a result of investment done initially (Merritt, 2019). PV Payback
Period takes into consideration the PV values of the yearly cash inflows to arrive at a more
accurate period as the time value of money is considered.
Advantages of the payback period are:
 It is simple to use and easy to understand as it needs relatively fewer inputs.
 It provides quick solutions as it is easy to calculate and requires fewer calculations.
 It is helpful in industries where there are rapid technological changes.
Disadvantages:
 It is not really as often investments are not done on a one-time basis and takes place on a
periodic basis.
 The main motive for undertaking a project is to earn profits, which this method ignores.
The only conclusion that can be drawn from this method is the period in which the initial
investment can be recovered.
The Accounting Rate of Return takes into consideration the accounting aspects of the project.
The depreciation needs to be considered in this method as it forms a part of the accounts and
helps to identify return from the project on the face of financials.
Advantages:
 It considers the concept of profit after tax and depreciation. As for project accounting,
both of these are important things to be considered.
 This project helps to calculate profit and provide for taxation in the accounts.
Disadvantages: