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By Dividend Policy Yohanes Kristiawan Hartono 16668 Yulia Martha 16870 Juventius Willieyanto Rudmel 16933 Caroline Eva Mursito 16945 International Business Management Program Atma Jaya University Yogyakarta Summary The financial statements had been prepared and circulated to the directors of The New York Wave Corporation. This year’s performance ended a long streak of ”down” years and mounting losses. The big question on everyone’s mind was “When will they ever pay a dividend?” That was the main discussion at the board of directors’ meeting. There are 5 suggestions by 5 different people on how to deal with the problems faced by the company. As the directors gathered together for the meeting, Joe Smolinski raised his hand, “Why fix it, if it aren’t broke? I think we should continuo retaining all our earnings and use the money for future investment.” Right enough, up went Jim Barker’s long arm. “I think we owe it to our shareholders. They have waited a long time for a dividend and might vote with their feet if we don’t pay any dividends. I think we should identify our existing shareholder groups and make a decision based on what the majority prefers.” Janet Long says: does not care about this topic, and she prefers to move on to more important issues. Bob McKay said, “I think we should use the ‘residual dividend’ approach so that we can keep our shareholders happy and maintain our target capital structure.” Edwin has somewhat a different suggestion. He said, “Why don’t we figure out how much we can afford to pay out based on our immediate investment needs and target capital structure and then repurchase stock at the prevailing market price with what’s left over. That way, there would be less of a tax disadvantage to our rich clients and it wouldn’t be bad for our EPS either. Solutions 1. Joe Smolinski’s suggestion of not paying any dividend in order to provide the company with the cash to expand the project of the business. it is absolutely not a wise decision to retain 100% of the earnings unless the shareholders can be convinced to reinvest the earnings. This policy could be done due to the history told that New Wave Corporation is not paying dividend. This fact causes the investor to demand for a dividend every time the company gains profits. The Pros that can be achieved by the company are good sources of internal funds without having to pay floatation cost and less of a negative price on stock. Despite of the pros, it also has disadvantages such as a negative impact on stock price and the payment of dividends resolves some uncertainty regarding performance of the firm in the minds of investor. 2. Jim Baker’s argument is probably correct given the history of the company whether the stock price will suffer or not is depends on the desires of majority of shareholders. The company should be able to convince the shareholders that reinvested their money include the dividend they might attain. If the company succeeds, the stock price may not necessarily suffer. 3. The value of shareholder shares = the price of the share x the amount of shares = $ 0.25 x 1000 = $ 250 Shares that shareholder could sell off = The value of existing shares / the price per share = $ 250 / $ 8 = 32 shares The remaining shares = 1000 shares – 32 shares = 968 shares At $0.25 per share, the investor would be expecting $250 on 1000 shares. It could be sold off ($250/$8) = 32 shares, leaving with 968 shares. The arguments claim that this income (homemade dividend) is achieved by individuals adjusting their personal portfolios to reflect their own preferences. The homemade dividend is sale of a small percentage of holdings of a stock to obtain cash, stressing the similarity to receiving a cash dividend. Those shareholders who don’t like the dividend policy can create homemade dividends. They could sell off shares similar to the value of the dividends that they were expecting to receive and reinvest the cash from those sales into alternative investments. 4. Dividend policy is the decision regarding the magnitude of the dividend payout, the percentage of earnings paid to the stockholders in the form of dividends. The significant factor that affects the dividend policy is taxes. Tax disadvantages related with dividends is being taxed at a higher rate that capital gains and different groups of shareholders have different tax rates and exemptions. Based on the data we have, we can see that the majority shareholding groups are individual shareholders so we could not state the best sort of dividend policy that best suited for New Wave Corporation because we don’t have enough information to be considered. 5. New Wave Corporation The investment needed = $1,000,000 Market value of debt = $3,350,000 (from balance sheet, bonds trading at par) Market value of equity = $8,000,000 (1,000,000shares @$8 per share) Target capital structure Debt=3,350,000/11,350,000=29.5 % Equity= 8,000,000/11,350,000= 70.5% Net income available for dividend = $960,000 Equity portion of needed investment based on target capital structure = 0.705 x $1,000,000 = $705,000 Net income available for dividend at residual approach = 960,000 - 705,000 = $255,000 Dividend per share = 255,000 / 1,000,000 = 26 cent per share 6. A strict dividend residual policy can make dividend payout ratio fluctuate significantly each quarter leading to a very unstable dividend policy. Dividend cuts due to lower net income and/or increased investment opportunities can have long term negative effect on the stock price. Practically, Firm tends to follow a compromise policy based on adhering long term constant debt equity ratio and allowing the proportion to vary in short run. Some firm try to avoid drastic change in dividend payout ratio by creating two types of dividend: regular and extra. Extra dividends are paid during a good period as a bonus thereby creating little or no disruption during not so good period. Other firms use share repurchases as a way of returning capital to stockholders. 7. Ed's suggestion for the firm they would use $705,000 of the $960,000 net income for its investment, which means than It would buy back 31,875 shares from the current shareholders instead of paying out a dividend. . The shareholders in higher tax brackets would not have to pay the higher taxes on dividend income while a proportional drop in price normally accompanies cash dividends on the ex-dividend date, unlike stock buybacks. The advantage of the buyback method shows that the number of shares outstanding would go down (968,125 shares) and the EPS would reach $0.99 per share. The main advantage of a residual dividend policy that they can achieve is this policy helps to set a target payout, the earnings that need to be retained to back up the capital budget have to be calculated, then, the earnings that are left can be paid out in the form of dividends to the shareholders. Advantages of Repurchases stock are stockholders can tender or not, helps avoid setting a high dividend that cannot be maintained, repurchased stock can be used in take-over or resold to raise cash as needed, income received is capital gains rather than higher-taxed dividends, stockholders may take as a positive signal--management thinks stock is undervalued. 8. Based on the company purpose, it seems like it is better if the company didn't pay for the dividend. The optimal dividend policy is the one that maximizes the firm's value. The company also should reconsider this policy, because the absence of dividend payment may cause the investor to withdraw their investment which would then causes more troubles to the company. If they stick on the plan to pay the dividend and its history of not paying dividends to the investor, it would be better to use a residual dividend method accompanied by a stock buyback, because New Wave's stock is fairly cheap at $8 per share so they could justify the buyback to the IRS to help boost their EPS. The firm can keep the shareholders happy and maintain the target capital structure. It is more beneficial to the firm and also to the shareholder