Download Dividend Policy

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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