MAKERERE UNIVERSITY

COLLEGE OF BUSINESS & MANAGEMENT SCIENCES

BACHELOR OF SCIENCE IN ACTUARIAL SCIENCE YEAR THREE
BBS3110: PRINCIPLE OF FINANCIAL MANAGEMENT 2020/2021

COURSE WORK (1)

Name Student number Registration number

Tumwebaze Clarity 1800700022 18/U/022

Natukunda Natasha Amelia 1800723180 18/U/23180/PS

Nakato Jesca 1800723178 18/U/23178/PS

Murungi Lynette Dorcas 1800700021 18/U/021

Bukulu Christian 1800723158 18/U/23158/PS

Atwiine Gloria 1800741655 18/U/41655

Atuhaire Aidan Lucas 217011674 17/U/3117/PS

Nalutaaya Agnes Lunkuse 1800700023 18/U/023

Nahabwe Prossy 1800723181 18/U/23181/PS

 a) Advise management with reasons whether there is any benefit to be realized by
the business if it paid dividends

A dividend refers to a reward, cash or otherwise that a company gives to its shareholders.
Dividends can be issued in various forms such as cash payments or bonus shares. A
company’s dividend is decided by its board of directors and requires shareholders’ approval.
Since the decision to pay or not to pay dividends is very critical, companies employ a
dividend policy. The policy chosen must align with the company’s goals and maximize value
for shareholders. In this case, the shareholders of Opondo Ltd have not been paid dividends
for three years and are currently demanding for them. Below are the benefits to be realised by
Opondo Ltd in case it pays dividends despite the fact they are making losses.

Paying dividends indicates financial strength of a company. It means that a dividend paying
company is confident of generating enough free cash flow into the future to return some of it
to shareholders. If Opondo Ltd paid dividends, investors will see this as a sign of a
company’s strength and as a sign that management has a positive expectation for future
earnings.

Investors prefer companies that have a track record of paying dividends as it reflects
positively on its stability. A Pay out by Opondo Ltd would attract investors and send a clear,
powerful message about the company’s future prospects and performance. This indicates
predictive earnings to investors, even if the market price of the share dips thus making the
company a good investment.

An advantage of paying dividends is that they can influence shareholder loyalty. Firms that
have a history of regular dividend payments are always expected to maintain the frequent pay
outs if possible. In reference to the bird-in-hand fallacy theory, shareholders prefer the
certainty of dividends in comparison to the possibility of higher capital gains in future. If
Opondo Ltd pays dividends to its shareholders, their loyalty to the company would increase.

Paying dividends is a form of information signalling. When companies announce the

dividend payments, it gives a strong signal about the future prospects of the company. Paying
dividends would show that Opondo Ltd has high future prospects for the company. In
addition Opondo Ltd can also take advantage publicity they get during the time of the
announcements.
Opondo Ltd would derive demand for their stock if they paid dividends. Dividends are one
way of paying shareholders a return on their investment. The payments may be done through
cash, additional shares in the company or both. Such returns attract more investors which
would increase the prices of the firm’s stock hence an increase in the firm’s price and rising
of funds for the firm’s operation.

If the directors of Opondo Ltd pay dividends during the tight financial situation that they are
in at the moment, it would send a message to shareholders that the firm is ready to payout
even in times of financial hardship. This would encourage shareholders not to pull out of the
firm and even encourage more to invest.

Agency theory suggests that the separation of ownership and management is plausible
explanation for dividend payout. The payment of dividends helps to protect firms from
massive money reserve and also improper managerial behaviour leaving the firm with
adequate funds to run firm’s operations. The payment of dividends to the shareholders of
Opondo Ltd would reduce the amount of free cash flow and help the firm avoid abusive use
of corporate resources by managers who may have been using it to pursue their own interests.

Dividends support the stock price during a market downtown and reduce volatility. Several
studies have indicated that dividend paying firms outperform during bear markets and
recessions. This is because if the share price is falling and investors feel the dividend is safe,
then investors are going to be drawn to buy into the stock because of the yield alone. During
times when the markets are very weak the interest rates are usually very low which makes
dividend stocks look even more attractive compared to the risk free rate hence supporting
dividend stocks in a down markets.

Paying dividends reduces the uncertainty of shareholders. Given the fact that Opondo Ltd
shareholders were mounting pressure on the company, paying out the dividends will give
them more confidence in the company hence reducing their uncertainty. This will encourage
the shareholders not to leave and keep investing in the firm.

Paying dividends to shareholders increases the reputation of the company. If Opondo Ltd
pays dividends it will have a good reputation and will attract more investors to the company
which will increase its capital inflows and financing.
b) Given the situation above, recommend with justification whether it is appropriate
and acceptable to pay dividends as per shareholders claim

In our view, basing on the information given above about Opondo Ltd, we wouldn’t advise
the management to pay out dividends to the shareholders because of the reasons mentioned
below;

Payments of dividends to shareholders are bound by certain laws and according to The
Uganda Companies Act 2012 Act 1 section 116, “A dividend shall not be paid otherwise than
out of profits or past profits”. Dividends are paid only out of current profits or past profits
after providing for depreciation. The company should therefore not pay any dividends to the
shareholders because it has no profits and has accumulated losses worth two hundred million
Uganda shillings. The directors are not legally compelled to declare dividends.

The business needs to hold onto its current earnings so that it can fulfil its future requirement
of funds. Paying of dividends limits the business from capturing highly profitable investment
opportunities. Opondo ltd needs to increase future earnings and stabilise its financial position
so that it will not require reaching out for external sources of funding for additional capital
for new investments.

It is not appropriate for the business to pay dividends because it needs to have liquid
resources. These liquid resources are invested in the assets needed for work. Retained
earnings from past years are already invested in infrastructure and in equipment, supplies and
other assets and so are not being kept as cash. In the case of Opondo Ltd, there is an urgent
need for funds to be used as working capital and so it is not in a position to pay out cash
dividends because of its liquidity position.

It is not appropriate for Opondo Ltd to pay dividends before it caters for its financial needs.
Financial needs are funds required for foreseeable future investment. If the company has an
opportunity of investment which can fetch a higher return than interest or can minimise
losses, it’s more reasonable for the company to invest the cash rather than use it to pay out
dividends. It would be illogical for the management of the company to use part of the already
scarce funds to pay shareholders if they have the opportunity to invest the money in an
income generating activity which could lead to growth of revenue and future profits.

The business needs to hold on to its current earnings if it doesn’t have access to capital
markets. The firm’s ability to raise funds from the capital market also determines whether
they can pay out dividends or not. Easy access to capital is possible only when the companies
are well established and hence a profit- track record. Opondo Ltd is not yet established and
has found difficulty in raising funds from other people and institutions. Since the company is
already finding it hard to access capital market, they shouldn’t pay out dividends.

A firm should assess its financial condition and borrowing capacity before paying dividends.
A growth firm lacking liquidity may borrow to pay dividends. Considering the fact that
Opondo Ltd had already incurred massive losses and is a growing firm; it’s highly likely that
it would need to borrow funds to finance dividend payout. But this is not a sound policy. This
will negatively affect the firm’s financial flexibility hindering its capacity of raising external
funds to finance growth opportunities in the future.

The company should not pay dividends to avoid diluting the control of the existing
shareholders. Maintaining control over the company by the existing management group or the
body of shareholders is an important variable in influencing the company’s dividend policy.
When a company pays large dividends, its liquidity position is affected and it might have to
issue new shares to raise funds to finance its investments. The control of the existing
shareholders will be diluted if they do not want or cannot buy additional shares.

Payment of a dividend to shareholders leaves the company with fewer assets to meet
liabilities to creditors. One of the goals of a firm is to always maintain solvency (to have
more assets than the liabilities). Considering the massive losses Opondo Ltd has already
incurred, it’s advisable to maintain the remaining assets so as to avoid further debts.

Alternatively, the firm could issue out bonus shares as a way of paying out claims rather than
giving out cash dividends. Issue of bonus shares is the distribution of shares free of cost to the
existing shareholders. In this case, the directors would allocate the bonus shares
proportionately to the existing shareholders. Issue of bonus shares rather than cash dividends
in turn would prove beneficial to the shareholders in a number of ways such as;

• The receipt of bonus shares by the shareholder is not taxable as income.

• Indication of higher future profits
• Future dividends may increase
• The declaration of the bonus issue would have a favourable psychological effect on
shareholders.
Finally, as the appointed financial advisors we would advise the management of Opondo Ltd
to look into other profitable business opportunities other than production of juice from sour
fruit. This is mainly because this idea has failed to attract the target market so as to raise
desired returns from the project thus the losses. We encourage them to develop a new
strategic plan for the company so as to be able reassess opportunities, determine necessary
requirements and build a productive business.