Question 5 (this question has four parts a), b), c) and d) (20 marks)

Part a

Suppose management of Lilydale Sports Corporation decides to use cash to pay a dividend of $8,000,000, and then issues more shares to new shareholders to replace the cash. What will happen to the market value of the existing shares and shareholders wealth? Explain your answer clearly.

(5 marks)

Part b.

Deakin Ltd has announced a fully franked dividend of $1 per share. The company tax rate is 27.5 per cent. By how much should the share price fall on the ex-dividend date, if franking credits are fully valued?

(5 marks)

Part c.

Explain the likely effects on dividend-payout ratios of each of the followings.

1. Interest rates increase substantially;
2. Company profitability increases;
3. Prospectus requirements are tightened, increasing the cost of share issue;
4. Personal income (but not capital gains) tax are increased;

(6 marks)

Part c.

The imputation system encourages payment of high dividend. Companies that pay significant dividend may be left short of cash. Comment on this statement.

(4 marks)