Discuss the companys dividend policy between 20w9 and 20x3

Reference no: EM13864776

The table below shows earnings and dividends for XYZ Inc over the past five years.

	Net earnings	Net dividend
Year	per share	per share
	$	$
20W9	1.40	0.84
20X0	1.35	0.88
20X1	1.35	0.90
20X2	1.30	0.95
20X3	1.25	1.00

There are 10,000,000 shares issued and the majority of these shares are owned by private investors. There is no debt in the capital structure.

It is clear from the table that the company has experienced difficult trading conditions over the past few years. In the current year, net earnings are likely to be $10 million, which will be just sufficient to pay a maintained dividend of $1 per share.

Members of the board are considering a number of strategies for the company, some of which will have an impact on the company's future dividend policy.

The company's shareholders require a return of 15% on their investment.

Four options a.e being considered, as follows.

(1) Pay out all earnings as dividends

(2) Pay a reduced dividend of 50% of earnings and retain the remaining 50% for future investment

(3) Pay a reduced dividend of 25% of earnings and retain the remaining 75% for future investment

(4) Retain all earnings for an aggressive expansion programme and pay no dividend at all
The directors cannot agree on any of the four options discussed so far. Some of them prefer option (1) because they believe to do anything else would have an adverse impact on the share price. Others favour either option (2) or option (3) because the company has identified some good investment opportunities and they believe one of these options would be in the best long-term interests of shareholders. An adventurous minority favours option (4) and thinks this will allow the company to take over a small competitor.

Required

(a) Discuss the company's dividend policy between 20W9 and 20X3 and its possible consequences for earnings.

(b) Advise the directors of the share price for XYZ Inc which might be expected immediately following the announcement of their decision if they pursued each of the four options, using an appropriate valuation model.

Reference no: EM13864776

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