Pavlon plc has recently obtained a listing on the Stock Exchange. Ninety per cent of the company's

Question:

Pavlon plc has recently obtained a listing on the Stock Exchange. Ninety per cent of the company's shares were previously owned by members of one family, but, since the listing, approximately 60 per cent of the issued shares have been owned by other investors.

Pavlon's earnings and dividends for the five years prior to the listing are detailed below:

The number of issued ordinary shares was increased by 25 per cent three years prior to the listing and by 50 per cent at the time of the listing. The company's authorised capital is currently Â£25,000,000 in 25p ordinary shares, of which 40,000,000 shares have been issued. The market value of the company's equity is Â£78,000,000.
The board of directors is discussing future dividend policy. An interim dividend of 3.16p per share was paid immediately prior to the listing and the finance director has suggested a final dividend of 2.34p per share.
The company's declared objective is to maximise shareholder wealth.
The company's profit after tax is generally expected to increase by 15 per cent p.a. for three years, and 8 per cent per year after that. Pavlon's cost of equity capital is estimated to be 12 per cent per year. Dividends may be assumed to grow at the same rate as profits.
Required
(a) Comment upon the nature of the company's dividend policy prior to the listing and discuss whether such a policy is likely to be suitable for a company listed on the Stock Exchange.
(b) Discuss whether the proposed final dividend of 2.34 pence is likely to be appropriate:
(i) If the majority of shares are owned by wealthy private individuals;
(ii) If the majority of shares are owned by institutional investors.
(c) Using the Dividend Valuation Model give calculations to indicate whether Pavlon's shares are currently undervalued or overvalued.
(d) Briefly outline the weaknesses of the Dividend Valuation Model.

Cost Of Equity
The cost of equity is the return a company requires to decide if an investment meets capital return requirements. Firms often use it as a capital budgeting threshold for the required rate of return. A firm's cost of equity represents the...