The requirement here was for candidates to use the dividend valuation model to calculate the value of a proposed change in dividend policy, advising on its acceptability to shareholders. Candidates tended to struggle with this question, although some scored full marks.

The dividend valuation model allows us to calculate the value of an ordinary share or a company as the present value of its future dividends. If the future dividends are connected by a constant growth rate, we have the dividend growth model (DGM). In this question, the proposal was to suspend dividends for two years, before paying higher dividends at a higher growth rate than the current one from the third year onwards.

The DGM could be used to calculate a share price (the present value of future dividends from the third year onwards) at the end of the second year. This share price could then be discounted for two years to give a current share price. Some candidates adopted a different, but equally valid, approach of discounting the year 3 dividend to the end of year 1 or to year 0, and then applying the DGM.

How then would we know if the proposal was acceptable? By comparing the share price for the proposal to the current share price, calculated using the current dividend, the current dividend growth rate and the DGM.

General comments about whether shareholders would accept a two-year dividend suspensions, for example from the perspective of dividend relevance or irrelevance theory, were give some credit in the marking process. However, the expectation was that the comment on acceptability would refer to the comparison of the values discussed above.