Warner Body Works ppt

Case Study On Warner Body Works

Presented by,Minakshi PathakMoona BaralPadam ShresthaPragati DahalPrathana ShresthaRavi BhandariRithu MalekhuRubina Shrestha

Uniglobe collage of management (MBA 2nd)Date:2013/04/23

BACKGROUND Warner Body works is one of the leading producers of custom

coachwork for auto mobiles delivery trucks and other special purpose vehicles.

Warner body works acquired a number of small firms engaged in the research of robotics and material science as a move to broaden its product line.

It has followed liberal dividend policy due to which most of its stock holders are income-seeking rather than growth oriented.

Some argued that for the directors who owned large holdings of Warner stock it would be more profitable to retain earnings.

CONTD…..

Again it was argued that the company would loose the stock holders who were interested in high dividends which would lower their share price.

Looking at these arguments, the vice president of finance has to come up with the most appropriate solution to tackle the issue.

1. A CONTINUATION OF THE PRESENT POLICY OF PAYING OUT 60% OF THE EARNINGS.

Advantages: Individuals, organization, social organization that need stable

income would prefer this policy as it provides a regular dividend payment.

It minimizes uncertainty to investors as there is a regular payment of dividend.

A regular dividend policy decrease agency costs by reducing the free cash flow available to the managers of the firm.

Thus as per policy, Warner Body Works’ current stockholders is in support of high regular dividend.

Answer no.1

CONTD……

Disadvantage: This policy would not be appropriate where the companies

have low free cash flow because they are compelled to pay the regular dividend even if there are no earnings.

They pay high dividends, so they to bear opportunity cost of not investing in future projects.

 The high payment of dividend leads to low current ratio and increment of dividend.

If a firm pays out substantial dividends, it may need to raise external capital at a later stage through the sale of stock in order to finance the profitable investment projects.

2. LOWERING THE PRESENT PAYOUT TO BELOW 60% AND MAINTAINING THE PAYOUT RATIO RELATIVELY CONSTANT AT THIS NEW FIGURE. Advantages:

Lower dividend payouts can be preferred by individuals with upper tax bracket , given the immediate tax liability, in favor of higher capital gains with the deferred tax liability.

Low payouts can decrease the amount of capital that needs to be raised, thereby lowering flotation costs.

As there is less need to raise external equity, controlling interest of the stockholders will not be diluted.

•Dividend earnings are less risky than capital gains and this will help to reduce uncertainty.•With the reduction in the dividend payout, there is a risk that the current income seeking investors would sell their stock. Aggressive investors would more than take up that slack caused by possible liquidation of income seeking investors, which would result in the increase of the stock price if dividends were cut. •Since high dividends hurt investors, while low dividends-high retention help the firm's investors, low dividend stocks are more valuable to the company.

Contd……

CONTD……

Disadvantages: Lowering present payout below 60% might signal that

the firm is having financial difficulties. Hence the firm has reduced its dividend payout.

Majority of the Current stockholders \ would sell their stocks if the dividend payout ratio is reduced. This is because they are in favor of stable growth rate than growth potential.

3. A STABLE DOLLAR DIVIDEND POLICY

Advantage Investors may use the dividend policy as a part for information that is not easily accessible. In the case of Warner Body Works this could be a

better option as the firm needs to retain its earnings to support the acquisitions.

Disadvantage Fluctuation of the dividend year to year leads to investors to buy and sell stock to satisfy their

current needs. Income seeking investors would sell the stocks as

the dividend income is uncertain.

4. LOW DIVIDEND PAYOUT AND SUPPLEMENTING IT WITH EXTRA INCOME

Advantages: This policy could be considered right if the firm’s

earnings are quite volatile. If the firm does good earnings in some years,

it may pay extra dividends. This policy ensures that the investors get a certain

minimum amount as dividend. The investors have less expectation with this sort of

policy. This sort of policy prevents negative signaling as there is

a pre fixed minimum limit for those investors who are satisfied with the minimum level that is pre fixed.

CONTD…..

Disadvantages: There is an uncertainty in how much the investors are

getting as the dividend with this sort of policy; hence it may not attract those parties who are seeking a stable dividend.

 The investors might think that the company has a weak financial position, so it is going for a reduction in dividend payout which may be a cause for negative signaling to the investors.

ANSWER TO QUESTION NO:2

The advantage of announced dividend policy are: Attracts investors:o As the company is declaring a high dividend, many

companies would invest and thus it would lead the company for expansion opportunities.

Reduces uncertaintyo The biggest advantage of having an announced dividend

policy is that it would reduce investor uncertainty.

CONTD…… Reduction of cost of capital on future projects:o Dividend payment will naturally reduce the present profit but

will definitely reduce the cost of future equity funding.

Disadvantages: Difficult to alter the dividend policy once announced:o It is difficult for the company to change its dividend policy

once announced because change in policy would incur high cost.

Opportunity cost of reinvestment:o As the company has already declared the dividend to its share

holders, now the company is compelled to pay the dividend .

CONTD….

Not suitable for unionized company:o The announced dividend policy is not suitable for

unionized company because it will lead to conflict between the managers and the union.

Reduce credibility of the company:o In case if the company is not able to provide the

dividend to its shareholders that it had already declared then it will hamper the reputation of the company in future.

Answer no.3

  1997 2005

Net Income(EAT) 31.2 104.3

Share holder's Equity 97.3 487

Return on Equity(ROE) 32.07% 21.41%

Table1: Calculation of ROE

Here, g = ROE*(1 - DPR)Where, g = growth rate

ROE = Return on Equity , DPR = Dividend Payout RatioFor 1997, g = 32.07(1-0.6)

= 12.826% For 2005, g = 21.41%(1-0.6) = 8.56%

In the above calculation for the year 1997 given an ROE of 32.07% and a dividend pay out of 60% the growth rate is 12.8326%

Likewise for the year 2005 when ROE is 21.41% and a dividend pay out is 60% the growth rate in 8.56%

In the year 2005 the earning after tax has increased proportionally lower in comparison to Share holder's equity

This shows the lower growth rate in earning per share when dividend pay out ratio is constant @ 60%.

Contd.

Answer no.4.

Particulars Payout P/E

Playboy 17% 25

Uniroyal 0% 19

Hewlett Packard 11% 17

Datapoint 0% 16

Texas instrument 30% 13

Xerox 40% 10

ATT 67% 8

Allied Stores 45% 6

Selected Stock Market Data :

.Payout ratio identifies the percentage of net profit paid to stockholders in the form of dividends, over a specified time frame. Dividend payout ratio assesses the company’s ability to sustain its dividend payments, and is therefore useful predictors of continued profitability.

In the table companies having low payout ratio like Hewlett Packard (11%) and Playboy (17%) have high P/E ratios

Companies having high payout ratios like ATT (67%) and Allied Stores (45%) have low P/E ratios

However companies with payout ratio of(30%) and (40 %) have price earning ratio of 13 times and 10 times

It is seen that even those firms that do not pay dividend have high P/E ratios as compared to those who are paying dividends.

A low payout ratio represents a secure future, while a high ratio suggests that a company has failed to reinvest its profits and may not be able to sustain dividend payments.

For market with higher RE effect on MPS:Low payout High retention for more profitable project increased MPS high P/EThis in turn reduces the MPS and finally P/E ratio also declines.Low payout low profit decreased MPS low P/E

Contd.

price earning ratio and payout ratio both depicts the profitability of the firm. So theoretically they should have direct relationship. However the table shows the relatively inverse relationship.

Most organizations prefer to include certain portion of debt capital in their capital structure.

More debt capital means more amount to be paid as interest as well as loan.

With increased debt capital the firms are bound to several debt contracts.

Use of high amount of debt capital will make creditors reluctant to further provide loans.

Increased use of debt the return for equity shareholder would be riskier.

In the case of Warner Body Works it has followed liberal dividend policy.

Answer no. 5

ANSWERS NO.6

Opinion of Mark Bassler is that a reduction in the dividend payout rate would drastically reduce the price of the stock.

His argument is based on the fact that majority stockholders of Warner Body Works are income-oriented investor.

Roger Murray, suggests that a reduction in the dividend payout rate would incrssease the price of the stock.

His argument is verified by the fact that if dividend payout is reduced, income-seeking individuals would most likely sell off their Warner stocks for better paying stocks.

From the above evaluation of the two arguments, it can be seen that Murray’s argument has more weight than that of Bassler’s.

Reduction in the dividend payout rate would mean that the company can make acquisitions for cash.

QUESTION NO.7 MIGHT STOCK DIVIDENDS BE OF USE HERE?

A stock dividend is a dividend payment made in the form of additional share to owners of the common stock

Transform of certain amount from the firms retained earnings to capital stock account.

Benefits from stock dividend Conservation of cash (Increase liquidity) Tax benefits (70% tax on cash dividend & 28% on

Stock sell.) To keep market price of a share within popular trading

range Favourable psychological effect Investment opportunity Decrease in use of debt while financing capital

ANSWER NO. 8

Four alternative policies:

i) A continuation of 60% dividend payout ratio

ii) Lowering the present payout ratio to some percentage below 60%(i.e. 20,30,40 percent)

iii) Establishing a fixed dollar rate assuming the earnings will be increased.

IV) SETTLING A RELATIVELY LOW DIVIDEND PAYOUT OF ONLY $0.50, AND SUPPLEMENTING IT PERIODICALLY WITH EXTRA DIVIDEND THAT WOULD DEPEND ON AVAILABILITY OF FUNDS AND THE NEED FOR CAPITAL.

Here, the fourth policy of paying only $0.50 dividend is not suitable.Reason:Most the stockholders of the organization are income seeker who prefers high dividend payout ratio.

-JUSTIFY AMONG OTHER THREE ALTERNATIVES ON THE BASIS OF GROWTH RATE AND ON EARNING PER SHARE

 Table showing growth rate on various dividend policies

Dividend Policies Retention Ratio

Dividend Payout

Ratio ROE g %

First Dividend Policy

(favor of continuation of 60% dividend

payout ratio) 40% 60% 21.42 8.57

Second Dividend Policy

( favor of lowering the present payout

ratio)

DPR (20%) 80% 20% 21.42 17.14

DPR (30%) 70% 30% 21.42 14.99

DPR (40%) 60% 40% 21.42 12.85

Third Dividend Policy*

(favors establishing a fixed dollar rate) 48% 52% 21.42 11.44

HERE, MURRAY SHOULD RECOMMEND SECOND DIVIDEND POLICY, IN FAVOR OF LOWERING THE PRESENT PAYOUT RATIO. SINCE, THE HIGHEST GROWTH RATE ON EPS 80% WHEN DIVIDEND PAYOUT IS ONLY 20%.

ANSWER NO. 9

Payout

policy

Dividend in

million

EAT in

million DPS

Number of

share

outstanding

{million}

Average

Stock Price

0.2 20.86 104.3 0.42 50 14.62

0.3 31.29 104.3 0.63 50 14.62

0.4 41.72 104.3 0.83 50 14.62

0.6 62.58 104.3 1.25 50 14.62

The effect of these changes in optimal payout ratio further calculation is done as shown in the table below.

ANALYSIS OF THE CHANGES IN PAYOUT RATIO

As such when tax rate is reduced to 50% the stockholders will be benefited by (0.7*1.25 - 0.5*1.25)=$0.25.

reduction in capital gain also benefits the stockholders by extra 8% in principal.

As a result stockholders prefer to earn through capital gain or they seek for maximization of shareholder's wealth through expansion and growth.

CONCLUSION

 Dividend policy is a very important tool for any company.

Warner Body Works have avenues open for expansion opportunities with relatively high returns .

It follows a liberal dividend policy of paying out 60% of its earnings as cash dividends.

A higher debt in the capital structure would lead to higher demand for dividend from the part of equity holders.

Managers should focus on capital budgeting decisions and ignore investor preferences.

LESSON LEARNT

The key lessons learnt from this case are: Although a liberal dividend policy attracts investors, it is

not always beneficial for a company. A company following residual dividend policy can make

acquisitions for cash rather than issuing new stock. Stock dividends are better option than cash dividends. The tax advantage of capital gains favors retention of

earnings.