1. Using the following, i.e.

earnings in latest year = RM 1,000; b = 60%; R = 15%, explain

why the growth rate of earnings is = (b x R), and how does this lead to the dividend
growth model? (Clue: calculate the earnings for the following year). What is the growth
rate?

Net profit = 60% retained earnings (average return = 15% =growth rate = 0.6 x 0.15 =
9%) + 40% dividend

2. How can dividend policy damage shareholder interest when no external financing is
available? ( POPULAR EXAM QUESTION)

Yes, if the E(R)<Ke.

Dividend policy is a policy that company uses to decide how much it will pay to
shareholder in dividends. When the company has no external financing for
reinvestment, the company will use the residual dividend to fund for the investment RE.
This is cause the company to reduce or pay no dividend to the shareholder. It may look
bad to the shareholder, but if the investment expected return is better than the cost of
capital, it will bring benefit to the customer.
On the contrary, if the company invested with the dividends and the expected return is
lower than the cost of capital, this will damage the shareholder interest. Shareholder
would have better use of the dividend after distribution

3. What do you understand by the term ‘shareholder clientele’?

A group of shareholders with a preference regarding how much a company will pay out
in dividends, often for tax reasons. Dividend clientele usually make decision regarding
distribution based on which is most advantages to them.
Clientele groups are often dictated by age as well as income level. Older or retired
investors tend to prefer higher dividend income than younger shareholders, who prefer
that the company use free cash flows to fund growth rather than to distribute as
dividends future capital gain. Ultimately, dividend clienteles tend to be growth-versus-
income parties. The effects of dividend clientele on a company’s stock price are
somewhat controversial

4. What categories of shareholders are likely to prefer nearer-in-time dividends?

Bird in hand means preferable dividend payout. Senior shareholder that prefers regular
dividends payout

5. What are the arguments for a stable dividend policy?

Dividends resolve uncertainty in the minds of investors. It can be hypothesized that

stockholders might: Apply a higher discount rate (Ke), and Assign a lower valuation of
funds that are retained in the business
 Payment of dividends viewed more favorably than retained earnings to the stockholders
because of the information content of dividends.
Stockholders’ needs and preference go beyond the marginal principle of retained funds

6. Does it make sense for a corporation to repurchase its own stock? Explain.

EPS= Net profit / No of shares = 1million / 1million repurchase = 1 million / 500000

shares = $2
A corporation can make a rational case for purchasing its own stock as an alternative to
a cash dividend policy. Earnings per share will go up as the shares decline and if the
price-earnings ratio remains the same, the stock holder will receive the same dollar
benefit as if a cash dividend was paid because the benefits are in the format of capital
gains the tax may be deferred until the stock is sold.
A corporation also, may justify the repurchase of its own stock because it is at a very low
prices, or to maintain constant demand for the shares.
Required shares may be used for employee options or as a part of a tender offer in a
merger or acquisition.
Firms may also reacquire part of their stock as protection against a hostile takeover.
7. Discuss the difference between a passive and an active dividend policy.

A passive dividend policy suggests that dividends should be paid out if the corporation
cannot make better use of the funds. We are looking more at alternate investment
opportunities than at preferences for dividends.
If dividends are considered as an active decision variable the firm would retain the
earnings for future investments (retained earnings)