12/10/2012
Situation
Net Income $140.00
Target equity ratio 80%
Total capital budget $112.50
Number of shares 100
What would happen to the payout ratio and DPS if net income were forecasted to decrease to $90 million?
Net Income $90.00
Capital budget $112.50
Net income $90
Required equity (Equity ratio X Capital budget) $90
Payout ratio (Dividend/NI) 0.00%
What would happen to the payout ratio and DPS if net income were forecasted to increase to $160 million?
Net Income $160.00
Capital budget $112.50
Net income $160
Required equity (Equity ratio X Capital budget) $90
Chapter 14. Mini Case
Your new boss at the consulting firm Flick and Associates, which has been retained to help IWT prepare for its public offering, has asked
you to make a presentation to Jackson and Smithfield in which you review the theory of dividend policy and discuss the following
issues.
See Chapter 14 Mini Case Show
(3.) What do the three theories indicate regarding the actions management should take with respect to dividend payouts? Answer:
Answer: See Chapter 14 Mini Case Show
a. (1.) What is meant by the term “distribution policy”? How have dividend payouts versus stock repurchases changed over time?
talking with potential outside investors, they must decide on a dividend policy.
Integrated Waveguide Technologies, Inc. (IWT) is a 6-year old company founded by Hunt Jackson and David Smithfield to exploit
metamaterial plasmonic technology to develop and manufacture miniature microwave frequency directional transmitters and receivers
for use in mobile Internet and communications applications. The technology, although highly-advanced, is relatively inexpensive to
implement and their patented manufacturing techniques require little capital in comparison to many electronics fabrication ventures.
c. (1.) Assume that IWT has a $112.5 million capital budget planned for the coming year. You have determined its present capital
structure (80% equity and 20% debt) is optimal, and its net income is forecasted at $140 million. Use the residual distribution model
approach to determine IWT’s total dollar distribution. Assume for now that the distribution is in the form of a dividend. IWT has 100
million shares. What is the forecasted dividend payout ratio? What is the forecasted dividend per share?
Answer: See Chapter 14 Mini Case Show
(2.) The terms “irrelevance,” “dividend prefernce, or bird-in-the-hand,” and “tax effect” have been used to describe three major
theories regarding the way dividend payouts affect a firm’s value. Explain what these terms mean, and briefly describe each theory.
(4.) What results have empirical studies of the dividend theories produced? How does all this affect what we can tell managers about
dividend payouts? Answer: See Chapter 14 Mini Case Show
b. Discuss (1) the clientele effect, (2) the information content, or signaling, hypothesis, and (3) their effects on dividend policy. Answer:
See Chapter 14 Mini Case Show
Distribution = Net Income – [(Target equity ratio) * (Total capital budget)]
Capital budget $112.50
Net income $140
Required equity (Equity ratio X Capital budget) $90
Payout ratio (Dividend/NI) 35.71%
Payout ratio (Dividend/NI) 43.75%
Dividend per share $0.70
Declaration date:
Dividend goes with stock:
Ex-dividend date:
Holder-of-record date:
Payment date:
Inputs
Value of operations $1,937.50
Short-term investments $50.00
Debt $387.50
Number of shares 100.00
Value of operations $1,937.50 $1,937.50
+ Value of nonoperating assets 50.00 0.00
c. (3.) What are the advantages and disadvantages of the residual policy? (Hint: Don’t neglect signaling and clientele effects. Answer:
f. Suppose IWT has decided to distribute $50 million, which it presently is holding in very liquid short-term investments. IWT’s value of
operations is estimated to be about $1,937.5 million. IWT has $387.5 million in debt (it has no preferred stock). As mentioned previously,
IWT has 100 million shares of stock outstanding.
Prior to
Distribution
Thursday, November 14, 2013
Tuesday, December 10, 2013
Wednesday, December 11, 2013
Thursday, December 12, 2013
Friday, December 13, 2013
f. (3.) Suppose instead that IWT has just made the $50 million distribution in the form of a stock repurchase. Now what is IWT’s intrinsic
value of equity? How many shares did IWT repurchase? How many shares remained outstanding after the repurchase? What is its
intrinsic per share stock price after the repurchase?
c. (2.) In general terms, how would a change in investment opportunities affect the payout ratio under the residual payment policy?
e. What are stock repurchases? Discuss the advantages and disadvantages of a firm’s repurchasing its own shares. Answer: See
d. (1.) Describe the procedures a company follows when it make a distribution through dividend payments. Answer: See Chapter 14
d. (2.) What is a stock repurchase? Describe the procedures a company follows when it make a distribution through a stock repurchase.
If Distributed
as Dividend
Friday, January 3, 2014
f. (1.) Assume that IWT has not yet made the distribution. What is IWT’s intrinsic value of equity? What is its intrinsic per share stock
price?
f. (2.) Now suppose that IWT has just made the $50 million distribution in the form of dividends. What is IWT’s intrinsic value of equity?
What is its intrinsic per share stock price?
Value of operations $1,937.50
+ Value of nonoperating assets 50.00
Prior to
Distribution
Value of operations $1,937.50 $1,937.50
Growth in value of operations: 10%
Growth in distributions: 10%
Growth in debt: 10%
1. Distribute as Dividends
Section 2. Distribute as Repurchase
12/31/2013 12/30 12/31 12/30 12/31 12/30 12/31 12/30 12/31
Value of operations $1,937.5 $2,131.3 $2,131.3 $2,344.4 $2,344.4 $2,578.8 $2,578.8 $2,836.7 $2,836.7
+ Value of ST investments 50.0 55.0 0.0 60.5 0.0 66.6 0.0 73.2 0.0
Total intrinsic value of firm $1,987.5 $2,186.3 $2,131.3 $2,404.9 $2,344.4 $2,645.4 $2,578.8 $2,909.9 $2,836.7
− Debt 387.5 426.3 426.3 468.9 468.9 515.8 515.8 567.3 567.3
− Preferred stock 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0
Intrinsic value of equity $1,600.0 $1,760.0 $1,705.0 $1,936.0 $1,875.5 $2,129.6 $2,063.1 $2,342.6 $2,269.4
÷ Number of shares 100 100 100 100 100 100 100 100 100
End of Month Dec-2013 Dec-2014 Dec-2014 Dec-2015 Dec-2015 Dec-2016 Dec-2016 Dec-2017 Dec-2017
Price per share (Dividends) $16.00 $17.60 $17.05 $19.36 $18.76 $21.30 $20.63 $23.43 $22.69
Suppose the value of operations, available funds for distribution, and debt increase at 10% a year. Here is the impact of repurchases
versus dividends.
If Distributed
as Repurchase
Prior to
Distribution
Projected
2014
2015
2016
2017
$22.00
$24.00
$26.00
$28.00
Stock
Price
Price per share (Repurchase) $16.00 $17.60 $17.60 $19.98 $19.98 $22.69 $22.69 $25.77 $25.77
g. Describe the series of steps that most firms take in setting dividend policy in practice. Answer: See Chapter 14 Mini Case Show