Week 5 - Case Study

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Apr 3, 2024

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Case Study 1 Case Study: Mini-Case: Integrated Waveguide Technologies, (end of Chapter 14). Respond to Questions a (1), b, c, (1, 3) and e. A – 1. What is meant by the term “distribution policy”? How has the mix of dividend payouts and stock repurchases changed over time? Distribution policy is the manner in which a firm decides to pay profits to its investors. It could be either through dividends or stock repurchases and the amount that they payout depends

Case Study 2 upon how much they need to keep for future investment opportunities. Over the years dividend payout have reduced and increased stock repurchase program are being carried out by companies. B - Discuss the effects on distribution policy consistent with: (1) the signaling hypothesis (also called the information content hypothesis) and (2) the clientele effect.  Signaling content – Raising dividend is a signal that managers forecast good future earnings and leads to an increase in stock price, and the opposite if dividends are reduced. Investor’s view dividend changes as signals of management’s view of the future. Managers hate to cut dividends, so will not raise dividends unless they think raise is sustainable. Therefore, a stock price increase at time of a dividend increase could reflect higher expectations for future EPS, not a desire for dividends  Clientele effect – Different types of investors some which favor a higher dividend policy vs a low dividend policy. Impede changes in dividend policy. Although investors do not want to switch companies because of changes in payout policies as taxes and brokerage, managers have to be careful when deciding to change, dividend policies as stockholder shifts can occur, which can result in costs and capital gain taxes C – 1. Assume that IWT has completed its IPO and has a $112.5 million capital budget planned for the coming year. You have determined that 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. Suppose IWT has one hundred million shares.

Case Study 3  Net Income $140.00  Target equity ratio 80%  Total capital budget $112.50  Number of shares one hundred  Distribution = Net Income - [(Target equity ratio) * (Total capital budget)]  Capital budget $112.50  Net income $140  Required equity (Equity ratio X Capital budget)  Distributions paid (NI – Required equity) $50  Payout ratio (Dividend/NI) 35.71%  Dividend per share $0.50 What is the forecasted dividend payout ratio? What is the forecasted divided per share? What would it happen to the payout ratio and DPS if net income were forecasted to decrease to $90 million? To increase to $160 million? Net income was forecasted to decrease to $90 million  Net Income $90.00  Capital budget $112.50  Net income $90  Required equity (Equity ratio X Capital budget)  Distributions paid (NI – Required equity) $0  Payout ratio (Dividend/NI) 0.00%  Dividend per share $0.00

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Case Study 4 Net income was forecasted to increase to $160 million?  Net Income $160.0  Capital budget $112.50  Net income $160  Required equity (Equity ratio X Capital budget)  Distributions paid (NI – Required equity) $70  Payout ratio (Dividend/NI) 43.75%  Dividend per share $0.70 Payout ratio (Dividend/NI) 35.71% d ividend per share $0.50 Payout ratio (Dividend/NI) 35.71% d ividend per share $0.50 C – 3. What are the advantages and disadvantages of the residual policy? (Hint: Do not neglect signaling and clientele effects.)

Case Study 5 Advantages:  Stockholders can tender or not.  Helps avoid setting a high dividend that cannot be kept.  Repurchased stock can be used in takeovers or resold to raise cash as needed.  Stockholders may take as a positive signal--management thinks stock is undervalued. Disadvantages:  May be viewed as a negative signal (firm has poor investment opportunities).  IRS could impose penalties if repurchases were primarily to avoid taxes on dividends.  Selling stockholders may not be well informed, hence be treated unfairly.  Firm may have to bid up price to complete purchase, thus paying too much for its own stock. E – Discuss the advantages and disadvantages of a firm repurchasing its own shares. A company can repurchase its shares when it wants to consolidate ownership, preserve stock prices, return stock prices to real value, boost financial ratios, or reduce the cost of capital. Here are some advantages and disadvantages of making this move. Advantages:  Stockholders can choose to sell or not.  Helps avoid setting a high dividend that cannot be kept.  Income received is capital gains rather than higher-taxed dividends.  Stockholders may take as a positive signal--management thinks stock is undervalued. Disadvantages:

Case Study 6  May be viewed as a negative signal (firm has poor investment opportunities).  IRS could impose penalties if repurchases were primarily to avoid taxes on dividends. References: Brigham, E.F & Houston, J.F (2022) Fundamentals of Financial Management 16th Edition. Boston, MA. Cengage Learning.

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