Kwaito Sounds had a dividend payout ratio of 25% in the financial year ending June 30, 2020. The company is seeking your advice on whether it should maintain this payout ratio. It is also considering a number of major investment opportunities for the coming year. These are listed in Exhibit 4 below. The company intends to maintain its working capital at the same percentage of revenues next year as it has this year.

The beta calculated in Question 2A (b) is considered to be a good estimate of the beta for the next five years.

Exhibit 4: Kwaito Investment opportunities in the next year

PROJECT	Project Total Investment (R' million)	IRR on project (using CF to Equity)	Beta (Levered)
A	15	16%	1.60
B	30	15%	1.25
C	25	12.5%	1.00
D	20	11.5%	0.50

a. If revenues, net income and depreciation are all expected to grow at 20% next year, and the firm maintains its existing capital structure (in market value terms), how much can the firm afford to pay out as dividends after meeting working capital and capital budgeting needs?

b. The company's current cash balance is R10 million. What will happen to this cash balance if Kwaito Sounds maintains its payout ratio at 25% next year?

Answer rating: 100% (QA)

a If revenues net income and depreciation are all expected to grow at 20 next year and the firm maintains its existing capital structure in market value terms how much can the firm afford to pay out as dividends after meeting working capital and capital budgeting needs The amount that Kwaito Sounds can afford to pay out as dividends after meeting working capital and capital budgeting needs depends on several factors Firstly the company must determine how much working capital it needs to maintain its operations This includes funds for paying employees purchasing inventory and materials and meeting other expenses Secondly the company must factor in the cost of the capital investments it is considering This includes the total investment amount the internal rate of return IRR on the investment and the beta of the investment Once these factors have been taken into consideration the company can calculate how much it can afford to pay out as dividends To do this the company can use the following formula Dividend Payout Ratio Net Income Depreciation Capital Investment Amount x IRR Working Capital Amount Capital Investment Amount Using this formula Kwaito Sounds can calculate how much it can afford to pay out as dividends after meeting working capital and capital budgeting needs Assuming that net income depreciation and working capital are expected to grow at 20 and that the capital investment amounts IRRs and betas are as listed in Exhibit 4 Kwaito Sounds can afford to pay out a ... View the full answer