Case Study: Integrated Waveguide Technologies, Inc.
Integrated Waveguide Technologies, Inc. (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 communication applications. IWT’s technology, although highly advanced, is relatively inexpensive to implement, and its patented manufacturing techniques requires little capital as compared to many electronic fabrication ventures. Because of the low capital requirement, Jackson and Smithfield has 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 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.
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 upon how much they need to retain for future investment opportunities. Over the years dividend payout have reduced and more and more stock repurchase program are being carried out by companies.
b. Discuss (1) the information content, or signalling, hypothesis, (2) the clientele effect, and (3) their effects on distribution 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?
| |
| 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) | |
| Distributions paid (NI – Required equity) | $50 | |
| Payout ratio (Dividend/NI) | | 35.71% | |
| Dividend per share | | $0.50 | | |
| 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) | | |
| Distributions paid (NI – Required equity) | $0 | |
| Payout ratio (Dividend/NI) | | 0.00% | | |
| Dividend per share | | $0.00 | | |
| | | | |
| What would happen to the payout ratio and DPS if net income were forecasted to increase to $160 million? |
| Net Income | $160.00 | | | | |
| 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 | | |
(2). In general terms, how would a change in investment opportunities affect the payout ratio under the residual payment policy?
e. Discuss the advantages and disadvantages of a firm's repurchasing its own shares.