10 Evaluation of dividend policies. Energy Systems, a company which designs and manufactures sophisticated electronic energy control systems, has experienced a period of rapid growth in recent years. The directors will soon meet to discuss the company’s financial plan for the next five years. A key item on the agenda for the meeting is the discussion of the company’s dividend policy over the planning period.

The managing director has suggested that the following dividend policies should be considered:

1 Maintain the same divided payout ratio as in the current year; or 2 Increase the dividend per share by a constant 20 per cent per year.

The managing director’s objective is to avoid any reduction in dividends.

The company has ambitious growth plans and based on the company’s strategic business plan, the financial director has prepared the following forecast financial data:

Year Forecast EPS (pence)

Current 9.80 1 11.90 2 10.10 3 13.30 4 14.50 5 17.40 It is approaching the end of the current financial year and the directors are proposing a final dividend of 2.9p per share. An interim dividend of 1.02p per share has already been paid.

(a) As an assistant to the financial director you have been asked to calculate the dividend per share (DPS) and the dividend payout ratios for each of the two policies over the five-year period and comment on your findings.

Based on the information provided, state in your answer which policy, if any, you consider financially feasible and give your reasons.

(b)The financial director has now determined that, in order to be able to finance its planned investment programme over the five years, the company will need to retain at least 70 per cent of its earnings in years 1 to 3 and at least 50 per cent in years 4 to 5.

Show how this is likely to affect the proposed dividend policies over the five-year period. Assuming the directors do not wish to raise additional financing, indicate the maximum dividend payable.