FINANCIAL MANAGEMENT FOR
DECISION MAKERS
Finance block 4.2
TABLE OF CONTENTS
Chapter 9: Making Distributions to shareholders .................................................................................................. 2
Chapter 9: Multiple Choice Questions ................................................................................................................. 9
Chapter 10: Managing Working Capital ........................................................................................................... 11
Chapter 10: Multiple Choice Questions ........................................................................................................... 19
Chapter 11: Measuring and Managing Shareholders Value .......................................................................... 21
Chapter 11: Multiple Choice Questions ........................................................................................................... 31
Chapter 12: Business Mergers and share Valuation ......................................................................................... 33
Chapter 12: Multiple Choice Questions ........................................................................................................... 38
Mock exam: Financial Management for Decision Makers 4.2 ....................................................................... 40
1
,CHAPTER 9: MAKING DISTRIBUTIONS TO SHAREHOLDERS
Paying dividends:
Dividends Represent a return by a business to its
shareholders. Normally paid in cash, although it
could be paid with assets other than cash.
− There are legal limits on the amount that can
be distributed in the form of dividend
payments.
Record date Establish which shareholders will receive the
dividends declared.
Cum dividend Price including dividends payable.
Ex-dividends Lower than the cum dividend by the amount of the
dividend payable.
Dividend distribution in practice:
Dividend cover ratio The extent to which profits for a period, which are
available for dividend, cover the dividend
payment. The higher the ratio, the lower the risk
that dividends will be affected by adverse
trading conditions.
The inverse of this ratio is known as the dividend payout ratio. The lower this ratio, the lower the risk
that dividends will be affected by adverse trading conditions.
Average dividend cover ratios for businesses in a range of industries:
2
,Dividend targets in practice: Most popular is the dividend payout ratio
Dividend growth model:
1. Assuming constant dividends:
2. Assuming a constant dividend growth rate:
By increasing D1, the share price P0 will automatically increase, but more dividends today may mean
a decrease in the dividend growth rate, as there is less cash to invest in the business. The benefit of
an increase in the share price today may be cancelled by a decrease in future years’ dividends.
Dividend policy:
Does the pattern of dividends affect shareholder wealth?
1. The traditional view (impact): Shareholders prefer dividends now, because the amounts are
more certain. The implications for managers are that they should adopt as generous a dividend
policy as possible:
− Discount at a higher rate due to risk;
− Share price of a business planning to retain profits to pay dividends later would suffer;
− Consequently: distribute dividends now;
− Dividend policy has impact on shareholders’ wealth.
2. The modernist (Miller and Modigliani) view (no impact): Given perfect and efficient markets, the
pattern of dividends has no effect on shareholder wealth. The implication for managers is that
one dividend policy is as good as another and so they should not spend time considering which policy
should be adopted. Lower dividends can be compensated by increase in share price and vice-
versa. Individual shareholder adjusts to his requirements: low dividend, sell portion of shares and
high dividend, use money to buy more shares. Therefore its irrelevant for shareholders wealth. 0nly
a movement of funds from inside the business to outside, investments can impact shareholder wealth!
3
, The position assumes:
− No share issue costs for the business;
− No share transaction costs for the shareholders;
− No taxation.
Example:
4
DECISION MAKERS
Finance block 4.2
TABLE OF CONTENTS
Chapter 9: Making Distributions to shareholders .................................................................................................. 2
Chapter 9: Multiple Choice Questions ................................................................................................................. 9
Chapter 10: Managing Working Capital ........................................................................................................... 11
Chapter 10: Multiple Choice Questions ........................................................................................................... 19
Chapter 11: Measuring and Managing Shareholders Value .......................................................................... 21
Chapter 11: Multiple Choice Questions ........................................................................................................... 31
Chapter 12: Business Mergers and share Valuation ......................................................................................... 33
Chapter 12: Multiple Choice Questions ........................................................................................................... 38
Mock exam: Financial Management for Decision Makers 4.2 ....................................................................... 40
1
,CHAPTER 9: MAKING DISTRIBUTIONS TO SHAREHOLDERS
Paying dividends:
Dividends Represent a return by a business to its
shareholders. Normally paid in cash, although it
could be paid with assets other than cash.
− There are legal limits on the amount that can
be distributed in the form of dividend
payments.
Record date Establish which shareholders will receive the
dividends declared.
Cum dividend Price including dividends payable.
Ex-dividends Lower than the cum dividend by the amount of the
dividend payable.
Dividend distribution in practice:
Dividend cover ratio The extent to which profits for a period, which are
available for dividend, cover the dividend
payment. The higher the ratio, the lower the risk
that dividends will be affected by adverse
trading conditions.
The inverse of this ratio is known as the dividend payout ratio. The lower this ratio, the lower the risk
that dividends will be affected by adverse trading conditions.
Average dividend cover ratios for businesses in a range of industries:
2
,Dividend targets in practice: Most popular is the dividend payout ratio
Dividend growth model:
1. Assuming constant dividends:
2. Assuming a constant dividend growth rate:
By increasing D1, the share price P0 will automatically increase, but more dividends today may mean
a decrease in the dividend growth rate, as there is less cash to invest in the business. The benefit of
an increase in the share price today may be cancelled by a decrease in future years’ dividends.
Dividend policy:
Does the pattern of dividends affect shareholder wealth?
1. The traditional view (impact): Shareholders prefer dividends now, because the amounts are
more certain. The implications for managers are that they should adopt as generous a dividend
policy as possible:
− Discount at a higher rate due to risk;
− Share price of a business planning to retain profits to pay dividends later would suffer;
− Consequently: distribute dividends now;
− Dividend policy has impact on shareholders’ wealth.
2. The modernist (Miller and Modigliani) view (no impact): Given perfect and efficient markets, the
pattern of dividends has no effect on shareholder wealth. The implication for managers is that
one dividend policy is as good as another and so they should not spend time considering which policy
should be adopted. Lower dividends can be compensated by increase in share price and vice-
versa. Individual shareholder adjusts to his requirements: low dividend, sell portion of shares and
high dividend, use money to buy more shares. Therefore its irrelevant for shareholders wealth. 0nly
a movement of funds from inside the business to outside, investments can impact shareholder wealth!
3
, The position assumes:
− No share issue costs for the business;
− No share transaction costs for the shareholders;
− No taxation.
Example:
4
