Distributions to Shareholders and Capital Structure Decisions

| June 4, 2016

FIN534 Week 8 Scenario Script: An Overview of cash dividends; Procedures for Cash Dividends; and The pros and cons of dividends and repurchases

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Slide 1

Intro Scene

Slide 2

Scene 2

• Joe in front of TFC with Don

• End of scene

FIN534_8_2_Joe-1: Don, I am glad that I ran into you. I have some great news. Late last night I met with the board of directors and updated them on the expansion project. They really liked all the details and analyses that have gone into this project so far. However, two of the board members are concerned about our emphasis on retaining as much cash as possible.

FIN534_8_2_Joe-2: While our projections are showing that in the first expansion year, our cash account will take a significant hit, our fellow board members think that we should still continue to reward our shareholders through dividends. I explained to them that we are planning on a constant ten percent growth rate. While they were pleased with that move, they still want us to revisit our cash dividend distribution policy. They also want us to look at a cash budget for TFC since building a sustainable level of cash is one of our primary financial goals.

FIN534_8_2_Joe-3: So, please gather your team to work on this next assignment. I believe that if we provide the information that these board members want, then we will be on our way to expanding out west.

Good luck!

FIN534_8_2_Don-1: Joe, we are again up to the challenge. I am supposed to meet Linda and the Intern in the conference room now, so I’ll fill them in on this assignment. You can always count on us!

Slide 3

Scene 3

• Don in conference room with Linda

• Go to next slide

FIN534_8_3_Don-1: As you know things move fast around here. I met with Joe a few minutes ago and he has another assignment for us. The board of directors liked what we have done so far but they want more information on our dividend distribution policy and cash budget planning before they will make a decision on the project.

FIN534_8_3_Linda-1: Don, we are right on it.

Up until now we have been focusing on how TFC will generate cash flow. Now, we are going to look at ways we can use those free cash flows.

FIN534_8_3_Linda-2: Our free cash flows can be thought of as the amount of cash flow available to our investors after payment of the required operating expenses and other corporate actions.

FIN534_8_3_Linda-3: And in comparison with many companies, our effective ways to use this free cash flow are very similar. We use these cash flows to pay our interest expenses, reduce the principal portion of our debts, pay dividends, and purchase short term marketable securities. Another choice would be to repurchase company stock, but we have never done that.

FIN534_8_3_Linda-4: When we use free cash flows to pay down debt, we always need to keep in mind our capital structure. If we would pay down our debt entirely, then we would not be able to take advantage of the interest expense deduction.

FIN534_8_3_Linda-5: With purchasing marketable securities, it is a nice risk reducing move on our part in case we need cash immediately. But it still doesn’t feel like we are giving something back to our shareholders. That comes from our dividend policy. We have the option of issuing a stock dividend or a cash dividend. At our company, we are about cash, so that is the dividend we issue.

Let us review one of our most recent cash dividend distributions.

Slide 4

Scene 4

· Dollar Sign

· Linda speaking


FIN534_8_4_Linda-1: When we went public, we were not declaring dividends. However, as we generated more free cash flow, we started distributing a dividend as a type of reward for our shareholders.

FIN534_8_4_Linda-2: Here are some specifics about our most recent dividend. Typically companies pay dividends on a quarterly basis, but here, as you know, we are anything but normal. We pay dividends on an annual basis. Our most recent dividend was ten dollars a share. But we are projecting that to go up at a constant rate.

FIN534_8_4_Linda-3: Before actually paying a dividend we had to set a few dates. Earlier this morning I sent you an email that contained some helpful information on the different types of dates. Turn on your tablet and follow along as I go over each of the dates.

FIN534_8_4_Linda-4: Declaration Date– this is the date our board of directors met to decide if TFC should pay a dividend and how much. They also decide when the dividend payment would be made to the shareholders and would be eligible to receive it. This is also the date that TFC, for accounting purposes, takes on the liability of paying the dividend. The declaration date is also referred as the announcement date.

FIN534_8_4_Linda-5: Holder-of Record Date – This is the determination date of who gets paid. If someone is a shareholder on that date, they will receive the dividend. In other words, this is the date when TFC needs to know the rightful owner of a share of stock in regard to receiving a dividend. Keep in mind that this may not be the actual owner of a share of stock.

FIN534_8_4_Linda-6: Ex-dividend Date – This can be considered the actual owner date of the stock. In other words if a stock is traded on that date the new owner will receive the dividend. If it is traded the next day, the previous owner will receive the dividend. This Ex-dividend date is two business days before the Holder of Record Date

FIN534_8_4_Linda-7: Payment Date – This is the date the dividend is actually paid. On this date, the shareholders of record will be sent a check for the declared dividend. This is the last date of all of the dates.

Slide 5

Scene 5 – CYU

• Set up click and drag here

TFC would like you to match up one of their next dividend distribution with each term.

Declaration Date – Wednesday November 20, 2013

Holder-of-Record-Date – Thursday December 19, 2013

Ex-Dividend Date – Tuesday, December 17, 2013

Payment Date – Friday, January 10, 2014

(have the students match up the dates. If they get it wrong, you can put in:

Declaration Date is when the dividend is decided;

Holder-of- Record Date – when a shareholder gets the dividend

Ex-Dividend Date – two business days before Holder-of-Record Date

Payment Date – when the dividends are actually paid

Slide 6

Scene 6

• Linda speaking

• Reinvestment of Dividends

• Stock Dividends

FIN534_8_6_Linda-1: Great job. Our dividend policy is really important to us as our shareholders have invested in us and we want to reward them. Remember earlier when two of our board of directors wanted us to revisit our cash dividend policy? They know how much investor wealth means to us and making sure we are rewarding our owners is important. I am really glad they wanted us to look into this policy more.

FIN534_8_6_Linda-2:Another point about cash dividends is reinvestment of them for more stock. While we haven’t implemented it yet, we are considering a dividend reinvestment plan or DRIP as they are known to our shareholders. What happens here is instead of receiving a cash dividend, our shareholders can opt to purchase more shares of stock. The benefit of this is our shareholders will increase their stock balance in TFC. Also, shares are typically purchased at a discount. So it is a great offering for shareholders if they choose. We are however still reviewing the corporate action and may offer it in the future.

FIN534_8_6_Linda-3:Another option is to issue dividends in the form of stock instead of cash. We have never done that and would rather have our shareholders choose how they would like to use their investment. However, it is a good way for companies to give back to their shareholders.

Slide 7

Scene 7

• Don speaking

• Stock repurchase

FIN534_8_7_Don-1: Linda, great explanations. Also there is the stock repurchase option that we utilize. There are many reasons why we would repurchase shares in the secondary market.

FIN534_8_7_Don-2: First, we may need to look at our capital structure and offer more debt and less equity. We can do that by issuing debt and using the proceeds to buy stock.

FIN534_8_7_Don-3: Another reason has to do with stock options. If our employees decide to exercise them, we need to make sure we have available shares. By repurchasing stock, we can have a reserve for our employees when they exercise their options.

FIN534_8_7_Don-4: And our last reason has to deal with cash. If we have excess cash, we may repurchase shares. It really depends on our cash situation.

FIN534_8_7_Don-5: To date, TFC has not repurchased shares. It has been a corporate decision on our part, but it is something we revisit periodically as we are always looking for ways to increase shareholder wealth.

Slide 8

Scene 8

• Don in Conference Room

• Pros and Cons of Repurchasing stock

• Next slide

FIN534_8_8_Don-1: As I mentioned, we haven’t repurchased any shares; however, we revisit this option for a number of reasons.

FIN534_8_8_Don-2: Let’s look at some of the reasons we always look into this option.

Some advantages of repurchasing stock are as follows:

FIN534_8_8_Don-3: First, from a psychological standpoint, if we decide to repurchase stock, investors usually look at this as a good sign since the stock price is undervalued. It is believed that if TFC feels the stock is undervalued and can purchase it at a discount. So, timing is important here and in the public eye, investors would feel that the stock is an attractive investment.

FIN534_8_8_Don-4: Second, shareholders can get cash for shares. Typically shareholders will decide if they want to sell their stock when a repurchase is planned. This is different from a cash dividend where all shareholders need to receive the cash dividend. So choice is mainly at the discretion of the shareholder.

FIN534_8_8_Don-5: The third advantage is that it is pretty much the norm that companies only raise dividends; whereas reducing the cash dividend rate can be thought of as bad company business. Also if there is an anticipated positive cash flow that cannot be sustained, our company may decide that it is best to repurchase stock instead of paying out a cash dividend.

FIN534_8_8_Don-6: Fourth is capital structure. If we decide that our current capital structure of sixty percent equity and forty percent debt needs to be changed then a repurchase can do that. For example, when repurchasing stock TFC may decide to borrow lots of money. This would modify the capital structure as debt would increase.

FIN534_8_8_Don-7: Another advantage is that there are stock options. While TFC has never offered stock options, if we did we would need to have a supply of stock shares available to employees. Repurchasing stock is a way to build up a reserve for those options.

FIN534_8_8_Don-8: The last advantage is the cash dividend component factor. If a total dividend amount is set without regard to shares outstanding, and if shares are repurchased that means there will be more to go around in the form of dividends as there will be less stock outstanding.

Slide 9

Scene 9 –

· Linda in room

· Disadvantages of repurchasing shares

FIN534_8_9_Linda-1: Good points Don. But there are also some disadvantages to repurchasing stock. Let’s look at a few…….

FIN534_8_9_Linda-2:When looking at the price of a share of stock, cash dividends are generally considered to be more consistent than repurchasing shares. As we saw when we were pricing a share of TFC stock, we use a growth factor that is based on dividends growth, not repurchase of stock.

FIN534_8_9_Linda-3:Another disadvantage is awareness for the selling shareholders. While it may sound like a good idea that a shareholder wants to have more cash available, keep in mind that if they don’t know all the planned activities for a company, they may miss out on future stock price growth.

FIN534_8_9_Linda-4:And a big disadvantage involves the price paid to repurchase stock. If a company pays more than what the stock is worth, the remaining stockholders may see price fluctuations. For example, if a company repurchases shares at a price higher than what the market is asking, the stock will go up, but after the repurchase is done, the stock price will correct itself. So there is a chance the stock will be repurchased at an inflated price only to see it drop, which may not be beneficial to long term stockholders.

Slide 10

Scene 10

• Don

• Next screen

FIN534_8_10_Don-1: Linda you brought up some very good points and it is why we as a company have stayed away from repurchase actions. There are advantages to both.

FIN534_8_10_Don-2: For example, if we wanted to change our capital structure to fifty percent equity and fifty percent debt, repurchasing stock may help us achieve that goal if we had to acquire debt to pay for the repurchased shares. There is also a tax benefit. Taxes have to be paid on cash dividends and repurchasing stock. The difference is when they have to be paid. In our case, dividends are paid annually so shareholders have to report the dividend on their taxes.

FIN534_8_10_Don-3: Repurchases have to be reported as well but only when sold. If a shareholder decides to have shares repurchased after owning it for many years, the tax reporting transaction occurs when sold. So the shareholder has been able to defer paying taxes on any distribution if they don’t receive a dividend.

FIN534_8_10_Don-4: So there are many pros and cons, but at this time we at TFC have decided that it is best not to repurchase shares. But we are considering a stock split.

FIN534_8_10_Linda-1: A stock split? This is news hot of the press! Please tell us more

Slide 11

Scene 11

• Don – stock split

• Next Slide

FIN534_8_11_Don-1: We have seen tremendous growth here and our stock price has benefited from it. But at this point we think it may be too high.

FIN534_8_11_Don-2: Joe believes that when a price becomes too high there are some investors who we cannot reach. And you know how Joe wants to reach everyone that is working out and investing in us. While reaching everyone is not possible, making our stock attractive in price is. A stock split will enable us to do that.

FIN534_8_11_Don-3: With a stock split, everything works out the same mathematically. It is just how it is divided.

FIN534_8_11_Don-4: For example, if TFC’s stock price is trading at two hundred dollars a share and a shareholder owns one hundred shares, the shareholder’s value in TFC would be twenty thousand dollars. If we declare a stock split of two for one, what happens is the number of shares the stockholder owns is now multiplied by two or two hundred shares and the share price is divided by the same two for a per share price of one hundred dollars.

FIN534_8_11_Don-5: The shareholder’s value is still the same, but now the shareholder owns two hundred sharesat a share price of one hundred dollars a share. It is understood that with this stock split we can now reach more shareholders because our stock will be priced lower. And let’s not even mention the possibility of stock growth should the shares go up. Also, there is the optimal stock price level that we would want to reach. We are still uncertain as to what that would be for TFC, but too high of a price may push some investors away.

FIN534_8_11_Linda-1: Thanks Don. Do you think it is something we will implement now?

FIN534_8_11_Don-6: With this expansion project going on, we don’t know if the timing is right. But since we have you and the intern doing several analyses, we would like you to do some more research on the stock splits.

Slide 12

Scene 12


• Stock splits – plug in answers as in 2 answers with the first being new share price and second new shares owns

(share price, shares owned)

Linda and Don would like you to calculate the stock splits as follows:

Please calculate the following stock splits for a shareholder owning five hundred shares (500). Assuming TFC’s stock price is $200.

1) 2 for 1 split – answer ($100 share price; 1000 shares owned

2) 3 for 1 split ($67 share price; 1,500 shares owned)

3) 4 for 1 split ($50 share price; 2,000 shares owned

4) 5 for 1 split ($40 share price; 2,500 shares owned)

Correct feedback. Great job! When stock splits occur the share price will go down accordingly with the hope that additional investors will now have the funds to acquire an interest in the company.

Incorrect feedback. Nice try. New stock price is old stock price divided by split while new shares owned is old shares owned multiplied by the split.

Slide 13

Scene 13

• Linda talking about stock splits

FIN534_8_13_Linda-1: As you saw, the higher the stock split, the higher the number of shares owned and the lower the price. It is that inverse relationship, just like when we were pricing bonds. It is very interesting to see how finance is all related.

FIN534_8_13_Linda-2: One thing I know for sure is we really examined a lot with dividends at the request of our board members. I am sure they will be pleased with our analysis.

FIN534_8_13_Linda-3: Before we end the day, let’s go to Don’s office and review what we covered today.

Slide 14

Scene 14

• Don Summary slide

• Don’s office

Next Slide
FIN534_8_14_Don-1: I just reviewed your findings and what an excellent job on it. Joe is going to be pleased as will the board members.

FIN534_8_14_Don-2: Let’s review what we covered today. First we looked at our dividend policy and we learned that there are many dates that go into setting dividends, which also determines who is the rightfully owner of the dividends once payment is made.

FIN534_8_14_Don-3:We also looked at offering stock dividends instead of cash as a possible option to shareholders.

FIN534_8_14_Don-4:We then switched gears and looked at TFC repurchasing shares back from stockholders. While it isn’t something we are currently doing, we may revisit it in the future thanks to your research on it.

FIN534_8_14_Don-5:Finally, we looked at stock splits as a way of setting an appropriate share price for investors to consider.

FIN534_8_14_Don-6:The analysis again was well done and it will help answer a lot of questions that may arise by our board of directors and any interested party.

FIN534_8_14_Don-7:But the dividend policy was only one part of our assignment. They also want us to look at our cash budget.

FIN534_8_14_Don-8:Before we move onto that area of our assignment. Let’s get a workout in because as they say, “working out pays huge dividends to your health!”

Slide 15

Scene 15

• Closing slide

Closing slide

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