Question

Mr. Norman and Mr. Foster are both investors looking to buy financial assets. Mr. Norman prefers assets with the lowest prices while Mr. Foster prefers assets on the financial market with higher prices. Each of them currently has GHC 1,000 to invest and needs your assistance to know which asset to buy to suit their preference. The following information provides details of investment options. ​
a. Asset A is a bond with a coupon rate of 10% and pays semi-annual coupons. The par value is GHC 1,000, and the bond has 5 years to maturity. The yield to maturity is 11%.
b. Asset B is a stock whose dividend is expected to increase by 20% in one year and by 15% in two years. After that, dividends will increase at a rate of 5% per year indefinitely. The last dividend was GHC 100 and the required return is 20%.​
Which asset will Mr. Norman and Mr. Foster invest in?​[8 marks]

C. In the 2020 accounting year, investors made a number observations in terms of certain decisions some corporations were taking:
(i) The board of directors of some manufacturing and services companies decided to pay stock dividends instead of cash dividends;
(ii) On the other hand, the board of directors of majority of companies within the ICT industry decided to pay special cash dividends;
(iii) It was also observed that some the management of some companies had decided to repurchase shares while others were engaging in stock splits.

What could be the reason for these three decisions and choice of dividend payments by the boards of these companies and what will be the effect of such decisions on the outstanding number of shares and the share prices of these companies?

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Answer 1

Mr norman will invest in asset A(bond) because this is of lower price i.e GHC 646.646

Mr foster will invest in asset B (stock) because its price is higher i.e GHC 866.667

C-

(i) company decides to pay stock dividend because of the following reasons-

*to increase total number of outstanding shares

* to reinvest its cash flows instead of distributing it as a return

stock dividends increase the total number of shares outstanding but share prices decreases.

(ii)This is because

* Company tries to increase shareholders wealth by dividends as well as capital gains in the share value

In this case outstanding number of shares remain the same but share price increases with the payment of dividends.

(iii) companies might repurchase share to gain control over the ownership of the company . In this case the outstanding number of shares remain the same but the share prices increase due to increase in buying activity of shares which puts upward pressure on share price.

While stock splits affects both the number of shares outstanding as well as stock price