Ryan Holdings plc is a FTSE-350 company that had been in existence for over a century. It started off as a family business in 1898 in Watford, but now it is an international business that manufactures household equipment, and it has presence through various branches, subsidiaries, associates and joint-venture operations in over 50 countries mostly in Europe, North and South America.
The directors of Ryan Holdings are now considering investing in a capital project proposal which had just been approved for implementation by the board. The project, when implemented, would expand operations in the UK. The cost is estimated to be in the region of £100 million.
The board is currently considering two options for raising the required long term finance.
The first option being considered is the issuance of fresh equity capital through an offer for subscription to ordinary shares to the general public at the existing market price of 200p per share. The finance director is in favour of this option because in his opinion the current share price is at its peak now.
The second option being considered is to borrow the money from a commercial bank. The loan covenant specifies the following:
The industrial loan would be repaid over a period of 20 years, and interest payment starts immediately when the money is credited into the current account of the company.
The company would be expected to pay interest on the facility at a rate of 4% over the base rate of 5% per annum.
The company’s existing terms and conditions under which the loan capital can be raised includes the following special covenants:
The company’s debt/equity ratio should not exceed 40%
EBIT to interest expense ratio (also known as interest cover times) of not less than 10 times should be maintained.
The finance director has informed the board that the company’s current credit rating in the money market is very good, although not excellent. She is of the opinion therefore, that irrespective of the funding option adopted by the board, the company would be able to raise the required finance for the capital project.
Ryan Holdings plc earnings before interest and tax (EBIT) during the year ended 31st December 2014 were £150 million, and the company’s latest financial statements reveal the following information:
Total Assets (Non-current plus current assets) 425m
Financed by: Equity shares of 50p each 100m
Profit Retained 250m
8% Bonds repayable in 2029 75m
Irrespective of the option chosen, injection of the extra one hundred million pounds investment is expected to yield a profit before interest and tax in 2015, which is 30% higher than the 2014 result. The outstanding bond of £75m would continue to be serviced at an annual interest rate of 8% p.a. until it is fully paid off over the next 15 years. Also, Ryan Holdings plc plans to maintain its existing dividend policy of distributing cash dividends of 25 pence per share. It can be assumed that corporation tax rate would remain at 30 percent for the foreseeable future. Debt/equity ratios of 50 to 60 percent are normal in Ryan Holdings plc’s industry.
Write a report that:
Assesses the impact of the two alternative financing proposals on the company’s earnings per share (EPS), and calculate the EBIT-EPS indifference point.
Assuming the role of an independent financial consultant, write a report on the relative merits of the alternative proposals; your report should bring out the key factors which should be considered when deciding between debt and equity finance, and contain reasoned recommendations for adopting one or the other of the proposals. 30 marks
Adrian, Brian and Charles are non-executive directors in different multinational companies quoted on the London Stock Exchange which have been operating profitably for several years now. These three non-executive directors met recently at business lunch, and the dividend policies of their respective companies were vigorously discussed. Adrian noted that his company has consistently paid an average of 70% of earnings per share as ordinary dividends, which is considered relatively high when compared to other companies operating in the same industry. Charles on the other hand was surprised that his company has not paid any dividends at all for the immediate past five years. Brian’s company sometimes pays cash dividends, and sometimes pays bonus shares in an irregular manner.
They all argued about the impact of dividends on the pricing of shares listed on the Stock exchange, and whether dividend payments are truly relevant in maximizing the wealth of the company’s shareholders. Charles cited the dividend irrelevance theory and then suggested that the discussion is a waste of time since his company has a relatively high price despite not paying dividends for 5 consecutive years.
Explain the theory of dividend irrelevance, and critically discuss the theory in the light of the various arguments advanced against it by its critics by examining the dividend policy of at least one company listed on the Stock Exchange over a period of 5 years. 20 marks
Critically review the empirical evidence of the applicability of various dividend theories to companies listed on any Stock Exchange, and then critically discuss the various practical considerations that tend to influence the dividend decisions of companies 25 marks