Question TWO Below is an abridged statement of the financial position of Seshego Ltd. Assets ZAR Liabilities and equity ZAR Cash 7 600 Current liabilities 25 800 Other current assets 26 800 Unsecured 6% bonds 1 400 Fixed and non-current assets 39 200 Common stock (ZAR 10 par value) 16 000 Retained earnings 30 400 Total assets 73 600 Total liabilities & equity 73 600 Seshego Ltd., whose reported earnings have been steady, has been paying a dividend of ZAR 4.00 per share on its common stock equity capital over the last several years. The board of directors have recently announced a similar dividend payout for the year just ended. The firm's common stock is currently trading for ZAR 130 per share on the Johannesburg Securities Exchange (JSE). The board considers the JSE sufficiently efficient. Seshego has free cash flows that it seeks to disgorge to the shareholders for lack of an NPV positive project. At a recent board meeting, members express different views on possible ways of disgorging the cash. The board chairperson suggests that the stockholders should be rewarded with an additional one-off special dividend exactly equal to the normal dividend, which is ZAR 4.00 per share. Another member of the board suggests that, rather than a special dividend, the company should make a 1-for-4 bonus/scrip issue. The member argues that keeping the same dividend rate on the higher equity capital should provide better long-term rewards to stockholders and should have a more favourable impact on the share price. An executive member argues that the issue of additional stock will dampen the firm's earnings per share and adversely affect the stock price. In the member's view, the firm should repurchase 3% of its stock at a premium of 10% above the current market price. She argues that earning a substantial premium above the market price and the concomitant increased earnings per share attributed to the decline in the number of shares, should provide the most value to stockholders. One of the non-executive directors points out that the firm's key stockholders are largely sophisticated (unit trusts, endowment funds, and the like) and rational so that in a market with high levels of efficiency such as the JSE, each of the three proposals should provide the same value to stockholders. Required i. In reference to the non-executive director's comment, assess the theoretical effect of each of three proposals (special dividend, bonus issue and stock repurchase) on the wealth of a stockholder in Seshego Ltd. currently owning 1,000 shares. Show relevant calculations, and comment on your findings. (10 marks) ii. Discuss each of the proposals and the views expressed by the board members and comment on the manner in which each of their comments may generate additional value to stockholders in practice. (7 marks)
