Page 23 - CIMA SCS Workbook August 2018 - Day 2 Suggested Solutions

CIMA AUGUST 2018 – STRATEGIC CASE STUDY

absolute level of extra revenue from digital advertising was nowhere near enough to make up for
the absolute level of revenue lost in print advertising.

As long as we set suitable targets (challenging but achievable) for the new KPIs in the Balanced
Scorecard, we should be able to monitor performance much better using this new approach.

EXERCISE 2

Email

To: Den Rice, CFO
From: Senior Manager
Subject: Dividends

Introduction
I have explained below the main considerations when setting a company’s dividend policy, and I
have addressed the concerns that Fiona Finch and John Small raised in their emails.

Setting a dividend policy

Three inter-related decisions
The dividend decision can be seen as something of a balancing act. Given a certain amount of
available profit, the question is how much of it should be paid to the shareholders and how much
should be retained to finance the future growth of the company? On the face of it, more
dividends now means less available for future investment: therefore lower levels of future
growth; therefore less profit available in the future; and thus lower dividends in the future.

Whilst this tends to be seen as a decision of how to divide up the available profit (as above) the
company also needs to consider its cash position. The company may well have generated a
reasonable amount of profit but this may not be reflected in the cash balance.
However, the situation is further complicated by the availability of other sources of funds. If, for
example, debt funds could be used to finance the future growth then less of the profit is needed
so more can be paid as dividend. This is then linked to the decision about gearing levels.
Thus, the dividend decision, the investment decision, and the financing decision all affect one
another. No one decision should be taken without considering the impact on the other two.

Theoretical factors – Modigliani and Miller
There is no real theoretical answer to this problem. The available theory (Modigliani & Miller’s
dividend irrelevance theory) claims that it’s not a problem; if the company has available
investment opportunities with positive NPVs then these should take precedence over dividends.
In theory this will increase shareholder wealth whereas paying dividends does not.

However, the theory depends on a number of assumptions (the key ones being no differential
taxes and no transaction cost) which are simply not valid in practice.

82 KAPLAN PUBLISHING