Integrated Waveguide Technologies, Inc. (IWT) is a 6-year old company founded by

Question

Integrated Waveguide Technologies, Inc. (IWT) is a 6-year old company founded by Hunt Jackson and David Smithfield to exploit metamaterial plasmonic technology to develop and manufacture miniature microwave frequency directional transmitters and receivers for use in mobile Internet and communications applications. The technology, although highly-advanced, is relatively inexpensive to implement and their patented manufacturing techniques require little capital in comparison to many electronics fabrication ventures. Because of the low capital requirement, Jackson and Smithfield have been able to avoid issuing new stock and thus own all of the shares. Because of the explosion in demand for its mobile Internet applications, IWT must now access outside equity capital to fund its growth and Jackson and Smithfield have decided to take the company public. Until now, Jackson and Smithfield have paid themselves reasonable salaries but routinely reinvested all after-tax earnings in the firm, so dividend policy has not been an issue. However, before talking with potential outside investors, they must decide on a dividend policy. Your new boss at the consulting firm Flick and Associates, which has been retained to help IWT prepare for its public offering, has asked you to make a presentation to Jackson and Smithfield in which you review the theory of dividend policy and discuss the following issues.

PLEASE SHOW WORK !!!

1. Assume that IWT has a $110 million capital budget planned for the coming year. You have determined its present capital structure (60% equity and 40% debt) is optimal, and its net income is forecasted at $140 million. Use the residual distribution model approach to determine IWT’s total dollar distribution. Assume for now that the distribution is in the form of a dividend. IWT has 100 million shares. What is the forecasted dividend payout ratio? What is the forecasted dividend per share? What would happen to the payout ratio and DPS if net income were forecasted to decrease to $90 million? To increase to $160 million?

2. In general terms, how would a change in investment opportunities affect the payout ratio under the residual payment policy?

3. Suppose IWT has decided to distribute $100 million, which it presently is holding in very liquid short-term investments. IWT’s value of operations is estimated to be about $3,050.80 million. IWT has $725.50 million in debt (it has no preferred stock). As mentioned previously, IWT has 100 million shares of stock outstanding. Assume that IWT has not yet made the distribution. What is IWT’s intrinsic value of equity? What is its intrinsic per share stock price?.

4. Now suppose that IWT has just made the $50 million distribution in the form of dividends. What is IWT’s intrinsic value of equity? What is its intrinsic per share stock price?

Explanation / Answer

1 Capital Budget for next year $110 Million Funded by Equity (60%) $66 Million Debt (40%) $44 Million Net income $140 Million Amount that can be distributed (Net income - Equity capital budget) $140 - $66 Million = $ 74 Million Number of shares 100 million Dividend payout ratio = 74/140 million 52.9% Dividend per share = 74 million/ 100 million shares $0.74 / share Capital Budget for next year $110 Million Funded by Equity (60%) $66 Million Debt (40%) $44 Million Net income $90 Million Amount that can be distributed (Net income - Equity capital budget) $90 - $66 Million = $ 24 Million Number of shares 100 million Dividend payout ratio = 24/90 million 26.7% Dividend per share = 24 million/ 100 million shares $0.24 / share Capital Budget for next year $110 Million Funded by Equity (60%) $66 Million Debt (40%) $44 Million Net income $160 Million Amount that can be distributed (Net income - Equity capital budget) $160 - $66 Million = $ 94 Million Number of shares 100 million Dividend payout ratio = 94/160 million 58.8% Dividend per share = 94 million/ 100 million shares $0.94 / share 2 Under the residual payment policy, only the remaining profit, which are left after retaining them for the future investment purpose are distributed to the shareholders. So in the given situation, out of $110M capital budget planned for the next year, 60% were to be funded by equity, so when the net income was $140 Million, the payout ratio was 52.9 %, but when it reduced to $90 Million, the payout ratio become 26.7%, whereas when it increase to $160 million, the payout ratio was 58.8%. 3 Value of Operations $ 3050.80 Million Liquid short term investments $ 100 Million Debt $ 725.50 Million Value of IWT (Value of operations+ Short term investments - Debt) $2425.3 Million Intrinsic value of equity $2425.3 Million Intrinsic value of per share = $2425.3 Million/ 100 Million shares $24.253/share 4 Value of Operations $ 3050.80 Million Liquid short term investments ($100 Million - $ 50 Million distributed as dividend) $ 50 Million Debt $ 725.50 Million Value of IWT (Value of operations+ Short term investments - Debt) $2375.3 Million Intrinsic value of equity $2375.3 Million Intrinsic value of per share = $2375.3 Million/ 100 Million shares $23.753/share

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