mini case study

Welsh Meds Plc is a small but rapidly growing biotechnology company in Cardiff with annual revenues of 115 million. Last year's net income was 6.38 million. Founded in 2002 by Carwyn Thomas and Geraint Jones with the support of a venture capitalist, the firm's success has been remarkable. After a three year development phase, the

company's breakthrough was brought about by a drug called Enzyme Shield that was designed to treat immune system deficiencies (ISD). To fund the substantial increase in production capacity, which the owners decided should remain in-house, Carwyn and Geraint took Welsh Meds public, thereby taking advantage of the favorable stock market conditions of 2006. By issuing 2.8 million shares at 19, 53.2 million of equity were raised. Two years ago, Welsh Meds made its first annual dividend payment of 0.40 which increased by 15% last year. Ten months ago, the company received the Drug Administration Authority's approval the mass market Enzyme Shield Light, a derivative of its first drug was specifically targets ISD in younger children. As a result, last quarter company earnings are up 37%, compared to the previous quarter. Carwyn and Geraint are very optimistic about Welsh Meds' future and wonder if it is time to reward its shareholders with either a special one-time dividend of 2.50 or an increase of the annual dividend by 1.00. William Stewart, the company's CFO, however, suggests using half of the accumulated cash of 12 million to initiate a buy back. In addition, Mr. Stewart would like to reduce the company's debt by 4 million, thereby maintaining a cash reserve of only 2 million. Recovering from the global financial crisis when shares of Welsh Med fell by more than half, its current share price 17.38 is still, down 32% from its peak 25.55 of summer 2007. However, Carwyn and Geraint are very optimistic that the economic recovery will continue and that their company's share price will reach new highs within the next 2-3 years.

QUESTIONS

1. was it prudent to initiate annual dividend payments only 3 years after the IPO?
2. If a special one-time dividend was paid, how would it likely affect Welsh Meds' share price?
3. Would the share price reaction be different if the annual dividend was raised by 1.00 instead?
4. What is the current dividend payout ratio and how would it change if the annual dividend was raised by 1.00?
5. Based on the current share price of 17.63, determine the company's implied cost of capital

according to the dividend discount model (DDM).

1. how is the owner's optimistic view that the share price will reach new highs in 2-3 years? Is a share price of 25.55 or higher realistic under the current dividend growth rate assumption?
2. Is the commonly used DDM that assumes a constant and perpetual growth rate applicable to Welsh Meds? Explain.
3. How would the suggested debt reduction affect the company's P/E ratio, return on assets, and return on equity?
4. How would the suggested share repurchase affect the company's P/E ratio, return on assets, and return on equity?
5. Is a 2 million cash reserve sufficient for Welsh Meds? Explain.