Question 5b
DD Co has a dividend payout ratio of 40% and has maintained this payout ratio for several years. The current dividend per share of the company is 50c per share and it expects that its next dividend per share, payable in one year’s time, will be 52c per share.
The capital structure of the company is as follows:
| $m | $m | |
|---|---|---|
| Equity | ||
| Ordinary shares (par value $1 per share) | 25 | |
| Reserves | 35 | |
| 60 | ||
| Debt | ||
| Bond A (par value $100) | 20 | |
| Bond B (par value $100) | 10 | |
| 30 | ||
90 |
Bond A will be redeemed at par in ten years’ time and pays annual interest of 9%. The cost of debt of this bond is 9·83% per year. The current ex interest market price of the bond is $95·08.
Bond B will be redeemed at par in four years’ time and pays annual interest of 8%. The cost of debt of this bond is 7·82% per year. The current ex interest market price of the bond is $102·01.
DD Co has a cost of equity of 12·4%. Ignore taxation.
Required:
(b) Discuss whether a change in dividend policy will affect the share price of DD Co. (8 marks)