Question 2 (20 marks)

Kowloon Iron and Steel Company Limited (KIS) is a listed steel manufacturer with 50 years of operating history. KIS has a dividend reinvestment plan which allows its shareholders to reinvest cash dividends in exchange for new shares of KIS without paying brokerage commissions. Due to changing business environment, the company has shifted its operation to overseas and mainland China, leaving a small manufacturing base in Hong Kong. A property developer has approached KIS to acquire the piece of land where its oldest steel mill is located. After considering its future business strategy, the management has recently decided to sell the piece of land, and the deal is expected to achieve $100 million aftertax profit. The management is now discussing the possibilities of using the extra cash.

(a) The CFO believes KIS should use the extra cash to pay a special dividend. Discuss how or whether it will affect the value of the company.

(b) The CEO prefers a share repurchase. Describe how a share repurchase affects (i) Price to Earnings (PE), (ii) Return on Assets (ROA), (iii) Return on Equities (ROE), and (iv) the value of the company.

(c) Explain the key assumptions in dividend growth model to value a stock. If these assumptions are invalid, discuss other possible valuation methods.

(d) Evaluate whether the dividend reinvestment plan will increase shareholder wealth.