11/21/2018
Situation
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%
theories regarding the way dividend payouts affect a firm’s value. Explain what these terms mean, and briefly describe each theory.
Answer: 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: See Chapter 14 Mini Case Show
(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
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.
a. (1.) What is meant by the term “distribution policy”? How have dividend payouts versus stock repurchases changed over time?
Answer: See Chapter 14 Mini Case Show
Integrated Waveguide Technologies (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. Because of the low capital requirement, Jackson and Smithfield have been able to avoid issuing new stock
and thus own all of the shares. Because of the explosion in demand for its mobile Internet applications, IWT must now access
outside equity capital to fund its growth and Jackson and Smithfield have decided to take the company public. Until now, Jackson
and Smithfield have paid themselves reasonable salaries but routinely reinvested all after-tax earnings in the firm, so dividend
policy has not been an issue. However, before talking with potential outside investors, they must decide on a dividend policy.
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?
Net Income $140.00
Target equity ratio 80%
Total capital budget $112.50
Number of shares 100
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%
What would happen to the payout ratio and DPS if net income were forecasted to increase to $160 million?
Net Income $160.00
c. (2.) In general terms, how would a change in investment opportunities affect the payout ratio under the residual payment policy?
Answer: See Chapter 14 Mini Case Show