Warner Body

8/3/2019 Warner Body

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CASE ANALYSIS- DIVIDEND POLICYCase Presented by:

Sixit BhattaShristina Shakya

Sushil AdhikariRaju Upadhayaya

WARNERBODY WORKS


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General Background

Leading producer of custom coachwork forautomobile, delivery trucks, and special purposevehicles.

Seeking growth opportunities, but constrained bylow retained earnings as 60% is paid out individends.

Companys stock mainly owned by the incomeseeking investors, both institutional andindividual.

Large Stockholders under the tax bracket of 70%.

decrease in current ratio from 5.5 in 1987 to 1.71 in1995.

Increase in Debt ratio from 16.8% in 1987 to 60% in1995.


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Problem Statement

Arguments against the existing dividend policy: Liberal Dividend Policy of paying out 60%

dividend a major constraint for taking up theprofitable projects.

Liquidity problem signified by the reduction in thecurrent ratio over the years.

Increase in the debt ratio - more and more debt isbeing used to finance the acquisition of the assets.

Continuation of the existing dividend policy maylead to the financial crisis in Future.

Directors having large holdings in the WarnerStock under high tax bracket of 70%


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Problem Statement

Arguments for the liberal dividend policy: Firm following the liberal dividend policy for past

30 years.

Purchases made by stockholders under the

assumption of continuation of the policy. Stockholders have overwhelming preference

towards the liberal dividend policy.

Decrease in the dividend policy may lead to the

negative financial signal in the capital market.


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Alternative Dividend Policies

Continuation of the existing dividend policy- 60%payout

A policy of lowering the present payout to somepercentage below 60 %

Establishing a dollar amount of dividends forexample, $1 per share.

Lower Dividend 50 cents per share plus extra.


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Yearly Dividend under various policies

60% 40% 30% 20%$1 pershare

$0.50 pershare

1995 $62.58 $41.72 $31.29 $20.86 $49.90 $24.95

1992 $36.90 $24.60 $18.45 $12.30 $35.96 $17.98

1987 $18.72 $12.48 $9.36 $6.24 $24.96 $12.48

1982 $4.56 $3.04 $2.28 $1.52 $10.00 $5.00

$-

$10.00

$20.00

$30.00

$40.00

$50.00

$60.00

$70.00

DividendinMil

lionDollars

Dividend under various Policies


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Yearly Retained Earnings.

60% 40% 30% 20%$1 pershare

$0.50 pershare

1995 $41.72 $62.58 $73.01 $83.44 $54.40 $79.35

1992 $24.60 $36.90 $43.05 $49.20 $25.54 $43.52

1987 $12.48 $18.72 $21.84 $24.96 $6.24 $18.72

1982 $3.04 $4.56 $5.32 $6.08 $(2.40) $2.60

$(10.00)$-

$10.00

$20.00

$30.00

$40.00

$50.00

$60.00

$70.00

$80.00

$90.00

R

etainedEarningsinMillionUS$

Retained Earnings


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Advantages of Existing Dividend Policy

Shareholders are happy and their trust is retained.Meets the high income expectation of the existing

shareholders.

Positive Financial Signal in the Capital Market.

Increase in the MPS.


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Disadvantages of Existing Dividend Policy

Less funds in Retained Earnings. Cannot Undertake profitable projects for growth

and diversification.

Large portion of the dividend paid out in the form

of the taxes, many stockholders under 70% taxbracket.

Decline in Liquidity and the Leverage Position ofthe company.

Dividends not stable due to the changes in the NetIncome.


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Advantages of Dividend Reduction below 60%.

Would help increase the retained earnings. Company can undertake profitable projects for

growth and expansion.

Can repay the portion of debt if no projects are in

the pipeline.Would help save taxes for the stockholders the

saving of taxes can be utilized for the growth.


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Disadvantages.

May lead to the negative financial signal in thecapital market leading to the decline in the MPS.

Would not meet the expectation of the Shareholderswho seek high income.

May reduce the MPS.


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Advantages- Fixed Dollar Amount Dividend

Stable Income for Stockholders. Lesser dividend than the existing policy of 60%

payout.

Larger retained earnings compared to the existing

Policy.Opportunities for expansion.

Increase in the Net Income does not influence thedividend amount.


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Disadvantages.

Amount more than the payout ratio of 40%.Decline in the performance of the company in the

future may tie up the funds.

Shareholders may become unhappy if the company

pays fixed amount dividend even if the Net Incomeis higher.


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Advantages- Lower Dividend 50 cents.

Large funds in Retained earnings. Tax Savings for the shareholders.

Flexibility for the management.

Opportunity to take up projects.

Opportunities to improve current and debt ratios.


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Disadvantages

Dividend may be well below the industry average. Investors may sell of their shares as they are income

seeking.

Decline in MPS as it provides negative financial

signal in the market.


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Advantages of Having announced the Policy

Provides the basis of Financial Planning to thecompany to plan future activity.

Facilitates the investors make purchase decision.

Provides Certainty to the investors.

Serves as a positive financial signal therefore helpsincrease the MPS.


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Disadvantages.

May restrict the firm take up lucrative andprofitable projects.

Less flexibility in utilizing the funds of the firm.

Difficult to retract from the policy if the firms

financial position deteriorates due to unforeseenreasons.


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Effect of the dividend policy on EPS

Dividend policy has a negative relation to thegrowth rate.

Liberal Policy declines the EPS therefore negativelyaffecting the growth rate.

Conservative policy allows better growth due to theincrease in the EPS.


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Relation between payout and P/E ratios

Particulars Payout P/E Ratio(Times)

Playboy 17% 25xUniroyal 0% 19x

Hewlett Packard 11% 17xData point 0% 16x

instruments 30% 13xXerox 40% 10xATT 67% 8x

Allied Stores 45% 6x


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Relation between Payout and P/E ratio

No evidence of direct relationship between the two.

There is a Decline in EPS due to the increase in theinterest because of the debt financing when largerdividend is paid out.

Mathematically,

EPS

MPSEP

IncomeNet

DividendTotalRatioPayout

/

_

__


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Debt Position Vs. Dividend Policy

Debt Position has huge effect in the dividendpolicy.

Large Debt- Conservative Policy

Less Debt- Liberal Policy.


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Murray Vs. Basslers Argument

Murray stresses on growth with the reduction inDividend using conservative policy.

Bassler Stresses on the Liberal Policy.

Developed Economies- Investors are growthconscious.

Developing Economics- Investors are Incomeconscious.

Short Run- Basslers Argument is valid.

Long Run- Murrays Argument is valid.


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Option of using the stock dividend.

Proportionate ownership remains the same.

Recapitalization.

Conservation of Cash.

Positive psychological effect on the stockholders.Might be a good option for the case.


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Risks of using Stock Dividend

Stockholders are income seeking investors.

Not a single growth oriented institution holds thestocks of the Warner Body Works.

Stockholders expect cash payout of 60%.

Overwhelming preference towards large dividend.


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Murrays recommended dividend policy

DividedPayout DividendM$ R/E,% R/E,M$ Tax ondividend Tax oncapital gain TotalTax60% 62.58 40% 41.72 43.81 11.68 55.550% 52.15 50% 52.15 36.51 14.60 51.140% 41.72 60% 62.58 29.20 17.52 46.730% 31.29 70% 73.01 21.90 20.44 42.320% 20.86 80% 83.44 14.60 23.36 38.0

Tax on Dividend= 70%Tax on Capital gains= 28%


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Murrays Recommendation

Cash Dividend payout of 30%

Stock Dividend payout of 30%

At 30% cash dividend equal amount of taxes onDividend and Capital gains.

Positive Psychological effect on the stockholders.

Firm Can take up profitable project with retainedearnings of 70%.

Large Retained Earnings can be used for

repurchasing the shares from Income seekinginvestors.

Less shares outstanding in the market wouldincrease EPS.


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Effect of Change in Tax Law.

Case Year 1995

Income 104.3 Million US$

Tax Rate on Dividend 50% (reduced from 70%)

Tax Rate on Capital Gains 20% ( reduced from 28%)

Payout Dividend $millionR/E,

%R/E, $

millionTax on

dividendTax on

capital gainTotal

Tax80% 83.44 20% 20.86 41.7 4.17 45.970% 73.01 30% 31.29 36.5 6.26 42.860% 62.58 40% 41.72 31.3 8.34 39.650% 52.15 50% 52.15 26.1 10.43 36.540% 41.72 60% 62.58 20.9 12.52 33.430% 31.29 70% 73.01 15.6 14.60 30.220% 20.86 80% 83.44 10.4 16.69 27.1


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Effect of New Taxation Policy

Provides with the larger dividend and Capital gainssaving compared to the earlier policy.

Optimum Policy of 30% payout does not change asit provides with almost equal tax amount.

Remaining 30% may be paid in the form of Stockdividend.

Payout of less than 30% does not justify as the taxeson the capital gains would be larger than that individend.


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Warner Body

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