IW Technologies (IWT) is a 6-year old company founded by Harold Jacksen and Donald Smith to exploit meta-material 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, JS 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 JS have decided to take the company public. Until now, JS 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.
Your new boss at the consulting firm FLT 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.
PART ONE
What is meant by the term “distribution policy”? How have dividend payouts versus stock repurchases changed over time?
The terms “irrelevance,” “dividend preference, 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.
750-1000 words
PART TWO
What do the three theories indicate regarding the actions management should take with respect to dividend payouts?
What results have empirical studies of the dividend theories produced? How does all this affect what we can tell managers about dividend payouts?
750-1000 words
PART THREE
Discuss (1) the clientele effect, (2) the information content, or signaling, hypothesis, and (3) their effects on dividend policy.
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? Show calculations
What would happen to the payout ratio and DPS if net income were forecasted to decrease to $90 million? Show calculations
What would happen to the payout ratio and DPS if net income were forecasted to increase to $160 million? Show calculations
In general terms, how would a change in investment opportunities affect the payout ratio under the residual payment policy?
What are the advantages and disadvantages of the residual policy? (Hint: Don’t neglect signaling and clientele effects.
Describe the procedures a company follows when it makes a distribution through dividend payments.
What is a stock repurchase? Describe the procedures a company follows when it makes a distribution through a stock repurchase.
What are stock repurchases? Discuss the advantages and disadvantages of a firm’s repurchasing its own shares.
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. Show calculations
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? Show calculations
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? Show calculations
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. Show calculations