George Liu, the CEO of Penn Schumann was a creature of habit. Every month he and Jennifer Rodriquez, the company’s chief financial officer, met for lunch and an informal chat at Pierre’s. Nothing was ever discussed until George had finished his favorite escalope de foie gras chaude. At their last meeting in thoughtfully with his glass of Chateau Haut-Brion Blanc before suddenly asking, “What do you think we should be doing about our payout policy?” Penn Schumann was a large and successful pharmaceutical company. It had an enviable list of highly profitable drugs, many of which had 5 or more further years of patent protection. Earnings in the latest 4 years had increased rapidly, but it was difficult to see that such rates of growth could continue. The company had traditionally paid out about 40% of earning as dividends, though the figure in 2011 was only 35%. Penn was spending over $4 billion a year on R&D, but the strong operation cash flow and conservative dividend policy had resulted in a buildup of cash. Penn’s recent income statements, balance sheets, and cash flow statements are summarized in Tables 17-4 to 17-6. The problem, as Mr. Liu explained, was that Penn’s dividend policy was more conservative than that of its main competitors. “Share prices depend on dividends,” he said. “If we raise our dividend, we’ll raise our share price, and that’s the name of the game.” Ms. Rodriquez suggested that the real issue was how much cash the company wanted to hold. The current cash holding was more than adequate for the company’s immediate needs. On the other hand, the research staff had been analyzing a number of new compounds with promising applications in the treatment of liver diseases. If this research were to lead to a marketable product, Penn would need to make a large investment. In addition, the company might require cash for possible acquisitions in the biotech field. “What worries me,” Ms. Rodriquez said, “is that investors don’t give us credit for this and think that we are going to fritter away the cash on negative-NPV investments or easy living. I don’t think we should commit to paying out high dividends, but perhaps we could use some of our cash to repurchase stock.” “I don’t know where anyone gets the idea that we fritter away cash on easy living.” Replied Mr. Liu, as he took another sip of wine, “but I like the idea of buying back our stock. We can tell shareholders that we are so confident about the future that we believe buying our own stock is the best investment we can make.” He scribbled briefly on his napkin. “Suppose we bought back 50 million shares at $105. That would reduce the shares outstanding to 488 million. Net income last year was nearly $4.8 billion, so earnings per share would increase to $9.84. If the price earnings multiple stays at 11.8, the stock price should rise to $116. That’s an increase of over 10%.” A smile came over Mr. Liu’s face. “Wonderful, he exclaimed, “here comes my homard a la nage. Let’s come back to this idea over dessert.” Evaluate the arguments of Jennifer Rodriquez and George Liu. Do you think the company is holding too much cash? If you do, how do you think it could be best paid out? Also, how much of the earnings would you consider paying to stockholder in the form of dividend? Table 17-4 Penn Schumann, Inc., balance sheet (figures in millions) 2011 2010 Cash and short-term investments 7,061 5,551 Receivables 2,590 2,214 Inventory 1,942 2,435 Total assets 11,593 10,200 Property, plant, & equipment 21,088 19,025 Less accumulated depreciation 5,780 4,852 Net fixed assets 15,308 14,173 Total assets 26,901 24,373 Payables 6,827 6,215 Short-term debt 1,557 2,620 Total liabilities 8,384 8,835 Long term debt 3,349 3,484 Shareholder's equity 15,168 12,054 Total liablities and equity 26,901 24,373 Note: Shares outstanding, millions 538 516 Market price per share ($) 105 88 Table 17-5 Penn Schumann, Inc., Income Statement (figures in millions of dollars) 2011 2010 Revenue 16,378 13,378 Costs 8,402 7,800 Depreciaiton 928 850 EBIT 7,048 4,728 Interest 323 353 Tax 1,933 1,160 Net Income 4,792 3,215 Dividends 1,678 1,350 Earning per share ($) 8.91 6.23 Dividends per share ($) 3.12 2.62 Table 17-6 Penn Schumann Inc., statement of cash flows (figures in millions of dollars) 2011 Net Income 4,792 Depreciation 928 Decrease (increase) in receivables (376) Decrease (increase) in inventories 493 Increase (decrease) in payables 612 Total cash from operations 6,449 Capital expenditures (2,063) Increase (decrease) in short-term debt (1,063) Increase (decrease) in long-term debt (135) Dividends paid (1,678) Cash provided by financing activities (2,876) Net increase in cash 1,510
Dividend Policy
A dividend is a part of the profit paid to the shareholder in an organization. The management of the organization has the right to decide the policy for giving a dividend from the earnings to the shareholder. However, an organization is not in the obligation to declare a dividend for the investor. Dividend policy differs from organization to organization. As the management has the only authority to decide dividend rate, dividend amount, and time of dividend payout by considering all other elements that create an impact on the payment of a dividend.
Stocks And Dividends
Stock or equities are generally sold and bought in the Stock Exchange or which is popularly known as the stock market. Stocks are issued in the Stock Exchange for the sole purpose of raising funds for the Corporation or the company itself. Now since an individual has purchased a portion of the Corporation or company, he or she may claim to be a part of the earnings or profit of the company.
George Liu, the CEO of Penn Schumann was a creature of habit. Every month he and Jennifer Rodriquez, the company’s chief financial officer, met for lunch and an informal chat at Pierre’s. Nothing was ever discussed until George had finished his favorite escalope de foie gras chaude. At their last meeting in thoughtfully with his glass of Chateau Haut-Brion Blanc before suddenly asking, “What do you think we should be doing about our payout policy?”
Penn Schumann was a large and successful pharmaceutical company. It had an enviable list of highly profitable drugs, many of which had 5 or more further years of patent protection. Earnings in the latest 4 years had increased rapidly, but it was difficult to see that such rates of growth could continue. The company had traditionally paid out about 40% of earning as dividends, though the figure in 2011 was only 35%. Penn was spending over $4 billion a year on R&D, but the strong operation cash flow and conservative dividend policy had resulted in a buildup of cash. Penn’s recent income statements, balance sheets, and cash flow statements are summarized in Tables 17-4 to 17-6.
The problem, as Mr. Liu explained, was that Penn’s dividend policy was more conservative than that of its main competitors. “Share prices depend on dividends,” he said. “If we raise our dividend, we’ll raise our share price, and that’s the name of the game.” Ms. Rodriquez suggested that the real issue was how much cash the company wanted to hold. The current cash holding was more than adequate for the company’s immediate needs. On the other hand, the research staff had been analyzing a number of new compounds with promising applications in the treatment of liver diseases. If this research were to lead to a marketable product, Penn would need to make a large investment. In addition, the company might require cash for possible acquisitions in the biotech field. “What worries me,” Ms. Rodriquez said, “is that investors don’t give us credit for this and think that we are going to fritter away the cash on negative-
Table 17-4 Penn Schumann, Inc., balance sheet (figures in millions)
2011 2010
Cash and short-term investments 7,061 5,551
Receivables 2,590 2,214
Inventory 1,942 2,435
Total assets 11,593 10,200
Property, plant, & equipment 21,088 19,025
Less accumulated
Net fixed assets 15,308 14,173
Total assets 26,901 24,373
Payables 6,827 6,215
Short-term debt 1,557 2,620
Total liabilities 8,384 8,835
Long term debt 3,349 3,484
Shareholder's equity 15,168 12,054
Total liablities and equity 26,901 24,373
Note:
Shares outstanding, millions 538 516
Market price per share ($) 105 88
Table 17-5 Penn Schumann, Inc., Income Statement (figures in millions of dollars)
2011 2010
Revenue 16,378 13,378
Costs 8,402 7,800
Depreciaiton 928 850
EBIT 7,048 4,728
Interest 323 353
Tax 1,933 1,160
Net Income 4,792 3,215
Dividends 1,678 1,350
Earning per share ($) 8.91 6.23
Dividends per share ($) 3.12 2.62
Table 17-6 Penn Schumann Inc., statement of
2011
Net Income 4,792
Depreciation 928
Decrease (increase) in receivables (376)
Decrease (increase) in inventories 493
Increase (decrease) in payables 612
Total cash from operations 6,449
Capital expenditures (2,063)
Increase (decrease) in short-term debt (1,063)
Increase (decrease) in long-term debt (135)
Dividends paid (1,678)
Cash provided by financing activities (2,876)
Net increase in cash 1,510
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