Question 1. Marking scheme

Transcription

1 Question 1 Text references. Cost of capital and APV is covered in Chapter 7a and free cash flow valuations in Chapter 7b. Stock exchange listings are covered in Chapter 2 and ethical issues in Chapter 3b. Top tips. For part (a) (i) you to know which formula to use to calculate the ungeared cost of equity. It is the MM Proposition 2 formula which is given to you in the exam. For (a) (ii) you should have picked up from the question information that the Bahari project needs to be valued using the APV method. To tackle (a) (iii) you need to work out what the bondholders stand to gain from the swap and compare it to the current value of the bond in order to decide whether or not they are likely to accept it. For part (b) make sure you only use the information contained in the question. Note that there is nothing saying the relationship between the president of Bahari and the CEO is inappropriate. Also consider what would happen to the farmers if Mlima Co does not take up the mining option. Note that your answer should be split evenly between the two issues. Easy marks. There are numerous easy marks to be picked up in part (a) (ii) for calculating the values for Mlima. (a) (iv) also offers some easy marks for some straightforward observations. Marking scheme Marks (a)(i) Explanation of Mlima Co s cost of capital based on Ziwa Co s ungeared 3 cost of equity Ziwa Co, cost of ungeared equity 4 (ii) Sales revenue growth rates 1 Operating profit rate 1 Estimate of free cash flows and PV of free cash flows for years 1 to 4 4 PV of free cash flows after year 4 2 Base case Bahari project value 2 Annual tax shield benefit 1 Annual subsidy benefits 1 PV of tax shield and subsidy benefits 1 Value of the Bahari project 1 (iii) Calculation of unsecured bond value 2 Comment 2 Limitation 1 (iv) Comments on the range of values 3 4 Discussion of assumptions 3 4 Explanation for additional reasons for listing 2 3 Assessment of reasons for discounted share price 2 3 Conclusion 1 2 Professional marks Report format 1 Layout, presentation and structure 3 (b) Discussion of relocation of farmers 4 5 Discussion of relationship between Bahari president and Mlima Co CEO Max 12 4 Max

2 (a) Report To: From: Subject: Date: Board of Directors, Mlima Co AN Consultant Initial public listing: price range and implications XX/XX/XX This report considers a range of values for Mlima Co to consider in preparation for the proposed public listing. These values are based on 100 million shares being issued. The assumptions made in determining these values are discussed and the likelihood of the equity-for-debt swap being successful is also considered. Finally the report will evaluate other reasons for listing and also why the shares should be issued at a discount. Mlima Co cost of capital Ziwa Co s ungeared cost of equity represents the return Ziwa Co s shareholders would require if Ziwa Co was financed entirely by equity. This return would compensate the shareholders for the business risk of Ziwa Co s operations. Since Mlima Co is in the same industry, and therefore faces the same business risk, this required rate of return should also compensate Mlima Co s shareholders. This rate would be used as Mlima Co s cost of capital as it is expecting to have no debt and therefore this rate does not need adjusting for financial risk. Therefore the cost of equity is also the cost of capital. This cost of capital is calculated in appendix 1 as 11%. Mlima Co estimated value Using the cost of capital of 11%, the value of Mlima Co is calculated as $564.9 million (see appendix 2 for full calculation), before considering the proposed Bahari project. The value of the Bahari investment, without considering the tax shield and subsidy benefits from the subsidised government loan, does not exceed the initial investment. When the tax and subsidy benefits are considered, the present value of the Bahari project is $21.5 million (see appendix 3 for full calculation). This gives a total value for Mlima Co of just over $586 million. This gives the following potential share prices, based on 100 million shares, including the effect of the suggested 20% share price discount. Potential share price Excluding Bahari project Including Bahari project Full value $5.65 per share $5.86 per share 20% discount $4.52 per share $4.69 per share Equity-for-debt swap The unsecured bond is currently estimated to be worth $56.8 million (see appendix 4 for full calculation). It is proposed that the existing bondholders will be offered a 10% stake in Mlima Co post-listing, which means that only the value at $5.86 per share would leave the bondholders better off, and therefore would be the only acceptable price. If the lowest price of $4.52 per share is used, then the equity stake would need to be around 12.6% for the bondholders to accept the offer (56.8m/4.52 = ). The bond value is based on a yield to maturity of 7%, because Mlima Co can borrow at 7%, so this is therefore its current yield. The yield could be more accurately estimated if it was based on future risk-free rates and the credit spreads for the company. Assumptions The main assumptions are over the accuracy of the estimates used in producing the valuation. The value of Mlima Co is based on estimated future growth rates, profit margins, tax rates and capital investment. The future growth rates and margins are based on past data, which may not be a reliable indicator of future prospects. The Bahari project includes estimated cash flows for 15 years and the reasonableness of these estimates needs to be considered to see if they are realistic. The cost of capital used for Mlima Co is based on Ziwa Co s ungeared cost of equity, on the basis that the business risk is the same for both companies as they operate in the same industry. However, it is possible that the business risks are different, for example due to geographic locations, and therefore the cost of 2

3 capital is not appropriate for Mlima Co. Accepting the Bahari project could also affect the business risk of Mlima Co. The value of the Bahari project is based on the Bahari government providing the promised subsidised loan. Mlima Co needs to consider whether the full subsidy will definitely be provided for the full 15 years and whether a change of government may change the position. There may also be other political risks which need to be assessed fully. Transaction costs for the listing have been ignored as they are assumed to be insignificant. It should be confirmed that this is the case before making a final decision. Reasons for a public listing The main reason behind this public listing is to remove the debt from the company. Other reasons for pursuing a public listing include: a gain in prestige for the company by listing on a recognised stock exchange, having greater access to sources of finance and being able to raise funds more quickly as a result, providing shareholders with a value for their equity stake and enabling them to realise their investment if they wish to do so. Issuing shares at a discount Since the public will only be issued 20% of the share capital from the initial listing, they will be minority shareholders and have a limited ability to influence the decision-making of Mlima Co. Even if they voted as a bloc, they would not be able to overturn the decision on their own. The discounted share price, would therefore, compensate the shareholders for the additional risk of being minority shareholders. The position of the unsecured bond holders should also be considered. On the assumption that they hold 12.6% of the equity (as discussed earlier) they could form a bloc with the new shareholders of 32.6%, which would be enough to influence company decisions. Whether they would form a bloc with new shareholders or are more closely aligned with the interests of the current owners is something that should be looked into. Shares are often issued at a discount to ensure that they all get sold. This is even more common for a new listing and the price of the shares does usually rise immediately after the listing. Conclusion A price range for the listing of between $4.52 and $5.86 per share has been calculated, depending on whether the Bahari project is undertaken and whether the shares are offered at a discount of 20%. It is recommended that Mlima Co consults the underwriters for the share issue, to carry out book-building to assess the price that potential investors are willing to pay. If 20% of the shares (20 million shares) are sold to the public at $4.52 per share, the listing will raise just over $90 million. $80 million would then be spent redeeming the secured bond, leaving just in excess of $10 million of funds remaining. Mlima Co needs to consider whether these funds will be sufficient to carry on its operations. The Bahari investment may result in a change to the desired capital structure of the company, which may also have an impact on the cost of capital. Becoming a listed company will also result in listing costs and additional annual costs to meet compliance and reporting requirements. These factors will need to be balanced against the benefits of listing before making a decision whether or not to proceed. Appendices Appendix 1: Mlima Cost of capital Ziwa Co market value of debt = 105/100 1,700m = $1,785m Ziwa Co market value of equity = 200m $7 = $1,400m Ziwa Co ungeared cost of equity using k eg = k eu + (1 t)(k eu k d ) D/E 16.83% = k eu (k eu 4.76%) 1,785/1, % % = k eu k eu = 10.93% (say 11%) 3

4 Appendix 2: Value of Mlima Co prior to Bahari project Past two years sales growth = = or 6.25% Expected growth for four years = % = 7.5% Operating profit margin (historic) /389.1 = /366.3 = /344.7 = Operating profit margin is expected to be 15%. Year $m $m $m $m $m Sales revenue (increasing at 7.5%) Operating profit (15%) Tax at 25% (15.7) (16.9) (18.1) (19.5) Additional capital investment (W1) (8.8) (9.4) (10.1) (10.9) Free cash flows * Discount factor (11%) ** PV of free cash flows Value of company = $564.9m * = 49.3 ** 1/( ) = Working Year $m $m $m $m Sales revenue Increase in revenue % of increase Appendix 3: Value of Bahari project Base case Year Free cash flow $m Discount factor 11% PV $m 0 (150) (150.0) (29.5) 10 year annuity discounted for five years = Annual tax shield benefit = 3% 150m 25% = $1.1m Subsidy benefit = 4% 150m 0.75 = $4.5m Total annual benefit = $5.6m Annuity factor (7%, 15 years) = PV of tax shield and subsidy benefit = 5.6m = $51.0m Adjusted present value = ($29.5m) + $51.0m = $21.5m 4

5 Appendix 4: Value of unsecured bond Annual interest = 13% 40m = $5.2m Assume a yield to maturity of 7%. A 10-year annuity factor at 7% is Discount factor for redemption of bond (7%, 10 years) is Bond value = 5.2m m = $56.8m (b) The activities of Mlima Co are likely to be of greater interest and be scrutinised more closely once it is listed. The company needs to consider the ethical implications of both situations and whether Mlima Co is complying with its own ethical code (if it has one). Regarding the relocation of the farmers, Mlima Co needs to judge where its responsibility lies. It may decide that this is a matter between the farmers and the government, and that Mlima Co is not responsible (either directly or indirectly) for the current situation. If Mlima Co does not agree to the offer, it seems likely that the mining rights would be given to another company and so the farmers situation would not improve by Mlima Co walking away from the deal. Mlima may be better off by influencing the government over this issue by asking it to keep the farmers together and to offer them more fertile land. In addition Mlima Co could offer jobs and training to any farmers who choose to remain where they are. In the case of the Bahari president and Mlima Co s CEO, Mlima Co must ensure that any negotiation was transparent and there was no bribery or other illegal practice involved. If the company and the government can show that decisions have been made in the best interests of the country and Mlima Co, and no individuals benefited from the decision, then it should not be seen negatively. Indeed, it is good for business to have strong relationships and this can create a competitive advantage. Mlima should consider how it would respond to public scrutiny of these issues, possibly even pre-empting issues by releasing press statements to explain positions. 5

6 Question 2 Text references. Acquisitions are covered in Chapters 9 and 10. Top tips. For part (a) make sure any synergies suggested are consistent with the given scenario, rather than a generic list. For example, R&D synergies are more applicable in this scenario than in a general acquisition question. For part (b) you may have slightly different numbers depending on roundings. Do not worry about this as full marks will still be given where roundings are sensible. For part (c) you need to use the maximum premiums calculated in part (b). Ensure that you use whatever numbers you have calculated in order to gain any follow through marks. Also for part (c) ensure that you justify the recommendation you have made and that it is supported by the calculations. Easy marks. You should be able to pick up some relatively straightforward marks in part (a) for distinguishing the different types of synergies as well as suggesting potential synergies in this scenario. Marking scheme Marks (a) Distinguish between different synergies 1 2 Evaluating possible financial synergies 2 3 Evaluating possible cost synergies 1 2 Evaluating possible revenue synergies 3 4 Concluding comments 1 2 (b) Average earnings and capital employed 1 After-tax premium 1 PV of premium (excess earnings) 1 Hav Co and Strand Co values 1 Combined company value 1 Value created/premium (PE method) 1 (c) Strand Co, value per share 1 Cash offer premium (%) 1 Cash and share offer premium (%) 2 Cash and bond offer premium (%) 2 Effect of basis risk on recommendation made 3 4 Max 9 6 Max (a) Synergies arise from an acquisition when the value of the new, combined entity is greater than the sum of the two individual values before the acquisition. There are three types of synergies: revenue, cost and financial. Revenue synergies create higher revenues for the combined entity, also creating a higher return on equity and an extended period of competitive advantage. Cost synergies arise from eliminating duplication of functions and also from economies of scale due to the size of the new entity. Financial synergies may result from the ability to increase debt capacity or from transferring group funds to companies where they can be best utilised. In this scenario, there may be financial synergies available as Hav Co has significant cash reserves, but Strand Co is constrained by a lack of funds. This means that the new entity may have the funds to undertake projects that would have been rejected by Strand Co due to a lack of funds. The larger company may also 6

7 have an increased debt capacity and therefore additional access to finance. It is also possible that the new entity will have a lower cost of capital as a result of the acquisition. Cost synergies may be available, through the removal of duplication in areas such as head office functions, but also in research and development. These synergies are likely to be more short-term. Other cost synergies may arise from a stronger negotiating position with suppliers due to the size of the new entity, meaning better credit terms and also lower costs. Revenue synergies have the potential to be the biggest synergies from this acquisition, although they are likely to be the hardest to achieve, and also to sustain. Hav Co can help Strand Co with the marketing of its products, which should result in higher revenues and a longer period of competitive advantage. Combining the research and development activity and the technologies of both companies may mean products can be brought to market faster too. To achieve these synergies it is important to retain the services of the scientist managers of Strand Co. They have been used to complete autonomy as the managers of Strand Co, so this relationship should be managed carefully. A major challenge in an effective acquisition is to integrate processes and systems between the two companies efficiently and effectively in order to gain the full potential benefits. Often, this is done poorly and can mean that the acquisition is ultimately seen as a failure. Hav Co needs to plan for this before proceeding with the acquisition. (b) (c) Maximum premium based on excess earnings Average pre-tax earnings of Strand Co = ( )/3 = $373m Average capital employed = [( ) + ( ) + ( )]/3 = $869.3m Excess annual premium (pre-tax) = 373 ( ) = $199.1m Post-tax annual premium = $ = $159.3m PV of annual premium in perpetuity = 159.3/0.07 = $2,275.7m The maximum premium payable is $2,275.7m Maximum premium based on PE ratio Strand Co s estimated PE ratio = = Strand Co s post-tax profit (most recent) = 397m 0.8 = $317.6m Hav Co s post-tax profit = 1, = $1,584m Hav Co current value = $9.24 2,400m shares = $22,176m Strand Co current value = $317.6 = $5,729.5m Value of combined company = (1, ) 14.5 = $29,603.2m Maximum premium = 29,603.2 (22, ,729.5) = $1,697.7m Current value of a Strand Co share = $5,729.5m/1,200m shares = $4.77 per share Maximum premium % based on excess earnings = 2,275.7/5, = 39.7% Maximum premium % based on PE ratio = 1,697.7/5, = 29.6% Cash offer: premium % to Strand Co shareholder ( )/ = 19.9% Cash and share offer: premium % to Strand Co shareholder 1 Hav Co share for 2 Strand Co shares Hav Co share price = $9.24 Price per Strand Co share = 9.24/2 = $4.62 Cash payment per Strand Co share = $1.33 Total return = = $5.95 Premium = ( )/ = 24.7% 7

8 Cash and bond offer: premium % to Strand Co shareholder Each share has nominal value of $0.25 so $5 is 20 shares Bond value $100/20 shares = $5 per share Cash payment per Strand Co share = $1.25 Total return = = $6.25 Premium = ( )/ = 31.0% Tutorial note: Although these evaluations have been carried out using the current share price given in the question, an equally valid approach would have been to have used a post-acquisition share price based on earlier calculations. Based on the calculations above, the cash plus bond offer will give the highest return to Strand Co shareholders. In addition, the bond can be converted to 12 Hav Co shares, giving a value per share of $8.33($100/12), which is below the current share price and so already in-the-money. If the share price increases over the 6-year period, then the value of the bond should also increase. The bond will also earn interest of 3% per year for the holder. The 31% return is the closest to the maximum premium based on excess earnings and higher than the maximum premium based on PE ratios. Thus this method appears to transfer more of the value to the owners of Strand Co. However, this payment method gives the lowest initial cash payment of the 3 methods being considered. This may make it seem more attractive to the Hav Co shareholders as well, although they stand to have their shareholding diluted most by this method, but not until six years have passed. The cash and share offer gives a return in between the other options. Although the return is lower than the cash and bond offer, Strand Co s shareholders could sell the Hav Co shares immediately, if they wish to. However, if the share price of Hav Co falls between now and the acquisition, the return to Strand Co shareholders will be lower. The cash only offer gives an immediate return to Strand Co shareholders, but it is the lowest return and may also place a strain on the cash flow of Hav Co, who may need to increase borrowings as a result. It seems most likely that Strand Co s shareholder/managers, who will continue to work in the new entity, will accept the mixed cash and bond offer. This maximises their current return and also gives them the chance to gain in the future when converting the bond. The choice of payment method could be influenced by the impact on personal taxation situations though. 8

9 Question 3 Text references. Hedging foreign currency transactions is covered in chapter 16. Gamma is covered in chapter 17. Top tips. In part (b) make sure you don t confuse payments and receipts in your matrix. Also it was important to read the scenario carefully to see that the spot mid-rate should be used, rather than any other rate. For part (c) don t waste time if you don t know what a gamma value is. Easy marks. There are some easy marks to be gained in part (a) for money market hedging and forward market calculations as these should be brought forward knowledge from F9. Marking scheme (a) Calculation of net US$ amount 1 Calculation of forward market US$ amount 1 Calculation of US$ money market amount 2 Calculation of one put option amount (1.60 or 1.62) 3 Calculation of the second put option amount or if the preferred exercise 2 price is explained Advice and recommendation 3 4 Max 12 (b) Construction of the transactions matrix 1 Calculation of the equivalent amounts of US$, CAD and JPY 4 Calculation of the net receipt/payment 2 Explanation of government reaction to hedging 3 10 (c) 1 mark per valid point Max 3 25 Marks 9

10 (a) (b) Only transactions between Kenduri Co and Lakama Co are relevant, which are Payment of $4.5 million Receipt of $2.1 million Net payment = $2.4 million The hedging options are: using the forward market, money market hedging and currency options. Forward market As selling for $, receive at lower rate. 2,400,000/ = 1,500,375 Money market hedge Invest US$ now: 2,400,000/( /4) = $2,381,543 Converted at spot 2,381,543/ = 1,494,255 Borrow in now 1,494,255 ( /4) = 1,509,198 The forward market is cheaper and therefore is preferred. Options Kenduri would buy Sterling put options to protect against a depreciating Exercise price $1.60/ 1 payment = 2,400,000/1.6 = 1,500,000 1,500,000/62,500 = 24 contracts 24 3-month put options purchased Premium = ,500 = $31,200 Premium in = 31,200/ = 19,576 Total payments = 1,500, ,576 = 1,519,576 Exercise price $1.62/ 1 payment = 2,400,000/1.62 = 1,481,481 1,481,481/62,500 = 23.7 contracts 23 3-month put options purchased payment = 23 62,500 = 1,437,500 Premium = ,500 = $49,163 Premium in = 49,163/ = 30,846 Unhedged amount = 2,400,000 (1,437, ) = $71,250 Hedging using forward market = 71,250/ = 44,542 Total payments = 1,437, , ,542 = 1,512,888 Both options hedges are worse than using the forward or money markets as a result of the premiums payable for the options. However options have an advantage over forwards and money markets because the prices are not fixed and the buyer can let the option lapse if exchange rates move favourably. Therefore the options have a limited downside, but an unlimited upside. Only with options can Kenduri Co take advantage of the $ weakening against the. Conclusion The forward market is preferred to the money market hedge. The choice between options and forwards will depend on whether management wants to risk the higher cost for the potential upside if exchange rates move in Kenduri Co s favour. Spot mid-rates are as follows US$1.5950/ 1 CAD1.5700/ 1 JPY132.75/ 1 10

11 (c) Paying subsidiary Receiving subsidiary UK USA Canada Japan Total receipts Total payments Net receipt / (payment) (add across) (add down) UK - 1, , , ,521.9 (39.7) USA 2, , , Canada , , ,106.0 (367.2) Japan - 2, , ,915.9 (505.4) Kenduri Co will make a payment of 39,700 to Lakama Co. Jaia Co will make a payment of 367,200 to Lakama Co. Gochiso Co will make a payment of 505,400 to Lakama Co. Multilateral netting will minimise the number of transactions taking place through the banks of each country. This limits the amount paid in fees to these banks. Governments who do not allow multilateral netting are therefore looking to maximise the transactions and fees that the local banks will receive. Other countries may choose to allow multilateral netting in the belief that this makes them more attractive to multinational companies and the lost banking fees are more than compensated for by the extra business brought to the country. Gamma measures the rate of change of the delta of an option. Deltas can be near zero for a long call option which is deep out-of-the-money, where the price of the option will be insensitive to changes in the price of the underlying asset. Deltas can also be near 1 for a long call option which is deep in-the-money, where the price of the option and the value of the underlying asset move mostly in line with each other. When a long call option is at-the-money, the delta is 0.5 but also changes rapidly. Therefore, the highest gamma values are when a call option is at-the-money. Gamma values are also higher when the option is closer to expiry. In this case, it appears that the option is trading near at-the-money and that it has a relatively short period before expiry. 11

12 Question 4 Text references. Financial strategy is covered in chapter 2 and dividend policy is covered in chapter 18. Top tips. For part (a) it is necessary to consider why Limni Co has these policies in place rather than just describing the existing policy. In part (b) you do not need to calculate dividend growth or payout ratios for every year to be able to pick up the marks, you can just consider overall growth and look at the earliest and most recent years to make sensible comments. It does not really matter which investment choice is recommended as long as you can support your choice with a valid argument. Part (c) requires you to know how to calculate dividend capacity. Ensure that you learn the adjustments required to profit after tax if you did not already know these. Easy marks. There are some easy marks to be gained in part (b) from the evaluation of dividend policies and the discussion of which company to invest in. Part (d) should also offer some fairly easy marks as long as the answer relates to the shareholders point of view, not the company s. Marking scheme (a) Evaluation of dividend policy 1 2 Evaluation of financing policy 3 4 Evaluation of risk management policy 1 2 Effect of dividends and share buybacks on the policies 2 3 Max 8 (b) 2 marks per evaluation of each of the three companies 6 Discussion of which company to invest in 2 8 (c) Calculation of initial dividend capacity 3 Calculation of new repatriation amount 2 Comment 1 2 Max 6 (d) 1 mark per relevant point Max 3 25 Marks (a) Dividend policy Many high-growth companies, such as Limni Co, retain cash instead of paying dividends and use the cash to help fund the growth. Many such companies declare an intention not to pay dividends and as such the shareholders expect their wealth to increase through capital gains rather than dividend payments. Financing Capital structure theory suggests that to take advantage of the tax shield on interest payments, companies should have a capital structure which is a mixture of debt and equity. Pecking order theory suggests that companies typically use internally generated funds before seeking to raise external funds (initially debt, then equity). The two main factors in deterring companies from seeking external finance are favouring one investor group at the expense of another and the agency effect of providing additional information to the market. Limni Co is following the pecking order theory to the extent that it is using internally-generated funds first. However it is then deviating from pecking order theory in looking to raise equity finance rather than debt even though it currently has insignificant levels of debt and is therefore not making full use of the tax shield. This may be explained by the fact that Limni Co operates in a high-risk, rapidly changing industry, where business risk is high. It may not want to take on high levels of financial risk by using significant levels of 12

13 debt finance. Other issues such as potentially restrictive debt covenant may also be a factor in the financing decision. Risk management Managing the volatility of cash flows enables a company to plan its investment strategy more accurately. Limni Co needs to ensure that it will have sufficient internally-generated cash available when it is needed for planned investments. More importantly, since Limni Co faces high levels of business risk, as discussed above, the company should look to manage the risks that are beyond the individual control of the company s managers. Affect on policies by returning funds to shareholders Returning funds to shareholders will affect each of these policies. The shareholder clientele could change, which may lead to share price fluctuations. However, since the change is being requested by shareholders, there is a good chance that this may not happen. The financing policy is likely to change since there will be less internally-generated funds available, so Limni Co may consider taking on additional debt finance and therefore will have to look at the balance of business and financial risk. This could in turn change the risk management policy as interest rate risk will also have to be managed as well. (b) (c) Theta Company Theta has a fixed dividend payout ratio of 40%. As a result the increase in dividends in recent years depends on the increase in profit after tax in these years rather than increasing at a steady rate, which is often preferred by shareholders. If profit after tax was to fall, Theta may reduce its dividend, which could send the wrong signals to shareholders and cause significant fluctuations in the share price. To avoid this, Theta may keep a stable dividend in years of reduced profits. Omega Company Omega has a policy of increasing dividends at approximately 5% per year, but earnings are only increasing at a rate of approximately 3% per year. This means the dividend payout ratio is increasing, it was 60% in 2009 and is 65% in Although this cannot continue in the long term, it suggests that there are less investment opportunities currently and Omega is reducing its retention ratio. This investment would be attractive to an investor looking for a high level of dividend income. Kappa Company Kappa has increased its payout ratio from 20% in 2009 to 27% in This is a fairly low payout ratio, but it is growing. Earnings are growing rapidly overall, but not at a constant annual rate (35% growth in 2010, but only 3% in 2011). Overall dividend growth is at a rate of 29% per year, and the annual dividend growth rate has been fairly constant. This policy seems consistent with a growing company, which is now starting to pay more significant dividends and return more funds to shareholders. This investment would be attractive to investors seeking a lower level of dividend income and higher levels of capital growth. Due to uncertainty about whether Theta could decrease its future dividend payments, Limni Co is likely to prefer to invest in either Omega or Kappa. The choice between these two depends on whether Limni Co would prefer higher dividends or higher capital growth. Issues such as taxation position or length of time that the funds would be invested for may influence this choice too. Current dividend capacity 000 Profit before tax (23% $600m) 138,000 Tax (26% $138m) (35,880) Profit after tax 102,120 Add back depreciation (25% 220m) 55,000 Less investment in assets (67,000) Overseas remittances 15,000 Additional tax (6% 15m) (900) Dividend capacity 104,220 Increase in dividend capacity = m 0.1 = $10.422m 13

14 Gross up to allow for extra 6% tax = $10.422m/0.94 = $11,087,234 Percentage increase in remittances needed = (11,087,234/15,000,000) 100% = 73.9% Dividend repatriations would need to increase by approximately $11.1 million or 73.9% in order to increase dividend capacity by 10%. Limni Co needs to consider both whether this is possible for the subsidiaries, but also the motivational and operational impact of doing so on the subsidiaries. (d) The main benefit of a share buyback scheme to a shareholder is that they can choose whether or not to sell their shares back to the company. This means they can control the amount of cash they receive and in turn manage their own tax liability. With dividend payments, especially with large special dividends, there may be a large tax liability as a result. Further benefits include the fact, that as share capital is reduced, earnings per share is likely to increase and share price may increase too. Additionally share buybacks are often viewed positively by the markets and share price may increase. 14