Question One. (Total 25 marks)
a. Big Bee Ltd has a cost of equity of 10%.Currently; it has 250,000 ordinary shares which are quoted at the stock Exchange at KES 120 per share. The company’s earnings per share are KES10 and it intends to maintain a dividend payout ratio of 50% at the end of the current financial year. The expected net operating income for the current year is KES 3 million and the available investment proposals are estimated to cost KES 6 million.
i. Using the Modigliani and Miller (MM) model, show that the payment of dividends does not affect the value of the firm. (8marks)
ii. What are the assumptions inherent in MM model? (2 marks)
b. Assuming all things are held constant other than the item in question, for each of the companies below:
i. A company with a large proportion of insider ownership, all of whom are highly income individuals.
ii. A growth company with an abundance of good investments opportunities.
iii. A company experiencing ordinary growth that has high liquidity and much unused borrowing capacity.
iv. A dividend paying company that experiences an unexpected drop in earnings from a trend.
v. A company with volatile earnings and high business risk.
Explain whether or not you would expect each company to have a medium/ high or low dividend payout ratio and the reasons for such categorization. (15 marks
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