Managerial Finance

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Part 6 Cash Distributions and Capital Structure

Investors are more concerned with future dividends than historical dividends, s

to ESTIMATES and scroll down to the Consensus Estimates section. Click on the

Available Measures menu to toggle between earnings per share and dividends per

share. What do analysts expect MSFT's payout policy to be in the future?

Refer back to the FULL COMPANY REPORT, and scroll down to the 5 Yr Annual

Balance Sheet section. Does it appear that MSFT has been repurchasing any stock, or

has it been issuing new stock?

Integrated Waveguide Technologies, Inc. (IWT) is a 6-year-old company founded by Hunt

|ackson and David Smithfield to exploit metamaterial plasmonic technology to dwelop and

manufacture miniature microwave frequenry directionai transmitters and receivers for use

in mobile Internet and communications applications" fWT's technology, although highly

advanced, is relatively inexpensive to implement, and its patented manufacturing techniques

requke little capital as compared 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 ali 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 |ackson and Smithfield have decided to take the company public. Until now, |ackson 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 \Mith potential

outside investors, they must decide on a dividend policy.

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 laclson 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 has the mix of dividend

payouts and stock repurchases changed over time?

(2) 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 these terms, and briefly describe

each theory.

(3) What do the three theories indicate regarding the actions management should take

with respect to dividend payouts?

(a) What results have empirical studies of the dividend theories produced? How does

all this affect what we crln tel1 managers about dividend payouts?

b. Discuss (1) the information content, or signaling, hlpothesis, (2) the clientele effect,

and (3) their effects on distribution poliry.

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.ZAo/o debt) is optimal, and its net income is forecasted

at $140 million. Use the residual distribution approach to determine IWT's total

dollar distribution. Assume for now that the distribution is in the form of a

dividend. Suppose IWT has 100 million shares of stock outstanding. What is the

forecasted dividend payout ratio? What is the forecasted dividend per share? What

would happen to the payout ratio and DPS if net income were forecasted to

decrease to $90 million? To increase to $160 million?

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