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.

5. Suppose instead that IWT has just made the $100 million distribution in the form of a stock repurchase. Now what is IWT’s intrinsic value of equity? How many shares did IWT repurchase? How many shares remained outstanding after the repurchase? What is its intrinsic per share stock price after the repurchase?

6. What are stock dividends and stock splits? What are the advantages and disadvantages of stock dividends and stock splits? Video you may find helpful. M&M Dividend Irrelevance Theory

7. What is operating leverage, and how does it affect a firm's business risk? Show the operating break-even point if a company has fixed costs of $1,000, a sales price of $18, and variables costs of $10.

Explanation / Answer

There is not enough data to compute intrinsic value of stock.

A stock dividend is a dividend paid in form of stock/shares instead of cash. A stock dividend is a distribution of shares to existing shareholders in lieu of a cash dividend. These type of dividends arise when a company wants to reward its investors but either doesn't have the capital to distribute or it wants to hold onto its existing liquidity for other investments. Stock dividends also have a tax advantage where they aren't taxed until the shares are sold by an investor. This makes them advantageous for shareholders who do not need immediate capital.

Stock splits occur when a company perceives that its stock price may be too high. Stock splits are usually done to increase the liquidity of the stock (more shares outstanding) and to make it more affordable for investors to buy regular lots (a regular lot = 100 shares). Companies tend to want to keep their stock price within an optimal trading range. For example, a two-for-one stock split means that the company stockholders will receive two shares for every share they currently own. The split will double the number of shares outstanding and reduce by half the par value per share.

Operating leverage is a measurement of the degree to which a firm or project incurs a combination of fixed and variable costs. A business that makes sales providing a very high gross margin and fewer fixed costs and variable costs, has much leverage. Operating leverage may be used for calculating a company’s breakeven point. Businesses with higher operating leverage do not proportionately increase expenses as they increase sales, those companies may bring in more revenue than other companies. However, businesses with high operating leverage are also more affected by poor corporate decisions and other factors that may result in revenue decreases.

The operating breakeven point for a business is the point at which sales revenue covers all of the fixed costs and variable costs but produces no profit for the business. In the given example, for every unit the company will sell, its going to get a margin of $8 ($18-$10), and its fixed cost is $1000. Dividing $1000 by $8 we get 125units. So the company must sell 125 units to break even.

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