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Question 3a

Chithurst Co gained a stock exchange listing five years ago. At the time of the listing, members of the family who founded the company owned 75% of the shares, but now they only hold just over 50%. The number of shares in issue has remained unchanged since Chithurst Co was listed. Chithurst Co’s directors have continued the policy of paying a constant dividend per share each year which the company had before it was listed. However, investors who are not family members have become increasingly critical of this policy, saying that there is no clear rationale for it.

They would prefer to see steady dividend growth, reflecting the increase in profitability of Chithurst Co since its listing.

The finance director of Chithurst Co has provided its board with details of Chithurst Co’s dividends and investment expenditure, compared with two other similar-sized companies in the same sector, Eartham Co and Iping Co. Each company has a 31 December year end.

Chithurst CoEartham CoIping Co
Profit for year after Interest and taxDividend paidNew Investment expenditureProfit for year after Interest and taxDividend paidNew Investment expenditureProfit for year after Interest and taxDividend paidNew Investment expenditure
$m$m$m$m$m$m$m$m$m
2012773318953830753537
2013803329(10)1515881764
201494332311044421183975
201597332112048291324284
Other financial information relating to the three companies is as follows:
Chithurst Co Eartham Co Iping Co
Cost of equity 11% 14% 12%
Market capitalisation $m 608 1,042 1,164
Increase in share price in last 12 months 1% 5% 10%

Chithurst Co’s finance director has estimated the costs of equity for all three companies.
None of the three companies has taken out significant new debt finance since 2011.

Required:
(a) Discuss the benefits and drawbacks of the dividend policies which the three companies appear to have adopted. Provide relevant calculations to support your discussion.

Note: Up to 5 marks are available for the calculations. (15 marks)

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