Limni Co is a large company manufacturing hand-held electronic devices such as mobile phones and tablet computers. The company has been growing rapidly over the last few years, but it also has high research and development expenditure. It is involved in a number of projects worldwide, developing new and innovative products and systems in a rapidly changing industry.

Due to the nature of the industry, this significant growth in earnings has never been stable, but has depended largely on the success of the new innovations and competitor actions. However, in the last two years it seems that the rapid period of growth is slowing, with fewer products coming to market compared to previous years.

Limni Co has never paid dividends and has financed projects through internally generated funds and with occasional rights issues of new share capital. It currently has insignificant levels of debt. The retained cash reserves have recently grown because of a drop in the level of investment in new projects.

The company has an active treasury division which invests spare funds in traded equities, bonds and other financial instruments; and releases the funds when required for new projects. The division also manages cash flow risk using money and derivative markets. The treasury division is currently considering investing in three companies with the following profit after tax (PAT) and dividend history:

All of the three companies’ share capital has remained largely unchanged since 2009.

Recently, Limni Co’s Board of Directors (BoD) came under pressure from the company’s larger shareholders to start returning some of the funds, currently retained by the company, back to the shareholders.

The BoD thinks that the shareholders have a strong case to ask for repayments. However, it is unsure whether to pay a special, one-off large dividend from its dividend capacity and retained funds, followed by small annual dividend payments; or to undertake a periodic share buyback scheme over the next few years.

Limni Co is due to prepare its statement of profit or loss shortly and estimates that the annual sales revenue will be $600 million, on which its profit before tax is expected to be 23% of sales revenue. It charges depreciation of 25% on a straight-line basis on its non-current assets of $220 million.

It estimates that $67 million investment in current and non-current assets was spent during the year. It is due to receive $15 million in dividends from its subsidiary companies, on which annual tax of 20% on average has been paid. Limni Co itself pays annual tax at 26%, and the tax authorities where Limni Co is based charge tax on dividend remittances made by overseas subsidiary companies, but give full credit on tax already paid on those remittances.

In order to fund the new policy of returning funds to shareholders, Limni Co’s BoD wants to increase the current estimated dividend capacity by 10%, by asking the overseas subsidiary companies for higher repatriations.

Required:

Evaluate the dividend policies of each of the three companies that Limni Co is considering investing in, and discuss which company Limni Co might select. (8 marks)