Question 3

Tesford plc has estimated net cash flows from operations (after interest and taxation) for the next five years as follows: Page 4 of 5

Year	Net cash flows ()
1 2 3 4 5	3,000,000 12,000,000 5,000,000 6,000,000 5,000,000

The cash flows have been calculated before the deduction of additional investment in fixed capital and working capital. This deduction amounts to 2m in each of the first two years and 3m for each year thereafter. The firm currently has a cash balance of 500,000 which it intends to maintain to cope with unexpected events. There are 24 million shares in issue. The directors are committed to shareholder wealth maximisation.

Required:

(a) Calculate the annual cash flows available for dividend payments and the dividend per share if the residual dividend policy was strictly adhered to. (5 Marks)

(b) If the directors chose to have a smooth dividend policy based on the maintainable regular dividend, what would you suggest the dividends in each year should be? Include, in your answer, the possibility of a special dividend or share repurchase. (15 Marks)

(c) Explain why companies tend to follow the policy in b rather than a. (5 Marks)