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Question 32b

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 $0·50 per share and it expects that its next dividend per share, payable in one year’s time, will be $0·52 per share.

The capital structure of the company is as follows:

$m $m
Equity
Ordinary shares (nominal value $1 per share) 25
Reserves 35
60
Debt
Bond A (nominal value $100) 20
Bond B (nominal value $100) 10
30

90

Bond A will be redeemed at nominal 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 nominal 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)

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