Question 5 (17 marks) Zita Company is a family owned company that has recently obtained a listing on the stock exchange. Before listing, 90% of the companys shares were owned by members of one family. Since listing, about 70% of the issued shares have been owned by other investors not related to the family. The companys business has been growing in the past 10 years steadily and the most recent 5 year data about the companys earnings and dividends are as follows: Years prior to listing Earnings after tax Dividend per share 5 $1,830,000 $1.26 4 $2,629,000 $1.45 3 $2,010,000 $1.11 2 $4,880,000 $1.92 1 $5,100,000 $2.00 Current year $5,642,000 (estimate) $1.60 The company currently has 1,400,000 shares of common stock. During the 5 years prior to listing, it has issued new shares twice. The number of shares was increase by 40% two years prior to the listing and by 25% 4 years prior to the listing. The board of directors are discussing the future dividend policy. A dividend of $1.60 per share was proposed by one of the directors to allow for greater amount of retained earnings for future growth.

a. Calculate the earnings per share and the dividend payout ratio for the current year and the 5 years prior to the listing and comment on the companys dividend policy to the listing. (9 marks)

b. Discuss whether the proposed dividend of $1.60 is appropriate if the majority of shares are owned by institutional investors such as insurance company and pension funds. (5 marks)

c. The director proposed $1.60 based on the residual dividend model. Suppose market interest rates suddenly rise, and Zita stock price declines as well. Assume firm's earnings, investment opportunities, and capital structure do not change. If Zita still follows the residual dividend model, then how the dividend payout ratio would change and explain why briefly. (3 marks)