SECTION A (20 marks)

Answer all questions in this Section

You are given a balance sheet and an income statement of a company. Use the financial statements to answer the following questions:

December 31 Balance Sheet

	2020 (RM million)
ASSETS
Cash and equivalents	10.00
Accounts receivable	375.00
Inventories	615.00
Total current assets	1,000.00
Net plant and equipment	1,000.00
Total Assets	2,000.00
LIABILITIES AND EQUITY
Accounts payable	60.00
Notes payable	110.00
Accruals	140.00
Total current liabilities	310.00
Long-term debt	754.00
Total Liabilities	1,064.00
Common stock (200,000,000 shares)	170.00
Retained earnings	766.00
Total Common equity	936.00
Total Liabilities and Equity	2,000.00

Income Statement for the Year Ending December 31

	2020 (RM million)
Net sales	3,000.00
Operating costs excluding depreciation	2,616.20
Earnings before interest, taxes and depreciation	383.80
Depreciation	100.00
Earnings before interest and taxes	283.80
Less interest	88.00
Earnings before taxes	195.80
Taxes	78.30
Net income	117.50

In addition, the company has allocated RM120 million to be spent on capital expenditure.

Questions

1. Residual dividend model is an approach commonly used by companies to determine their dividend payments. What is the residual dividend model? Describe some of its advantages and disadvantages. Provide the equation for the model.

(2 marks)

A business with a residual dividend policy holds zero excess cash at any given point in time. All spare cash must be either reinvested in the business or redistributed among the shareholders.

A residual dividend policy usually requires fewer new stock issues and lower floatation costs. However, a variable dividend policy may send conflicting signals to investors. It also represents an increased level of risk for investors, as dividend income remains uncertain.

2. Using the above information, determine the amount of forecast income that can be used as dividend payment if the forecast income is going to grow at the rate of 10% of the current level of net income and the capital structure remains at the current level.

(2 marks)

Dividend Payout Ratio = Net income [(Target equity ratio X Total Capital Budget)]

= 129.25 -

3. Assuming the total number shares outstanding remains at the current level, determine the earnings per share (EPS), dividend per share (DPS) and the payout ratio of this company.

(2 marks)

EPS = (net income preferred stock dividends) (outstanding shares)

= (117.5 -

DPS = (total dividends paid out over a period any special dividends) (shares outstanding)

DPR = Total dividends / Net income

4. If the forecast income level drops by 60%, due to COVID-19 and the capital structure of the firm capital structure remains at the current, determine the amount of income that can be used for dividend payment. Assuming the total number shares outstanding remains at the current level, determine the earnings per share (EPS), dividend per share (DPS) and the payout ratio of the company. Briefly describe the effect of the drop in income on the companys ability to make dividend payment. What are the necessary actions that need to be considered to overcome this problem?

(3 marks)

5. Supposed we are able to control COVID-19 pandemic next year and the economic and business forecasts appear to be much better. The net income is expected to grow at 20%, and the level of capital structure remains at the current situation, determine the amount of net income that can be used as dividend payment. Assuming the total number shares outstanding remains at the current level, determine the earnings per share (EPS), dividend per share (DPS) and the payout ratio.

(2 marks)

6. How would a change in investment opportunities affect dividends under the residual policy? Use the above computations to illustrate.

(2 marks)

Fewer good investments would lead to a smaller capital budget, hence a higher dividend payout.

More good investments would lead to a lower dividend payout.

7. Will the residual dividend policy provides a certain kind of signal to the companys shareholders and investors? Explain.

(2 marks)

8. Is this policy attractive for certain clienteles? Explain this in the context of the dividend policy issues. .

(2 marks)