Integrated Waveguide Technologies (IWT) is a 6-year-old companyfounded by Hunt Jackson and David Smithfield to exploitmetamaterial plasmonic technology to develop and manufactureminiature microwave frequency directional transmitters andreceivers for use in mobile Internet and communicationsapplications. IWT's technology, although highly advanced, isrelatively inexpensive to implement, and its patented manufacturingtechniques require little capital as compared to many electronics'fabrication ventures. Because of the low capital requirement,Jackson and Smithfield have been able to avoid issuing new stockand thus own all of the shares. Because of the explosion in demandfor its mobile Internet applications, IWT must now access outsideequity capital to fund its growth, and Jackson and Smithfield havedecided to take the company public. Until now, Jackson andSmithfield have paid themselves reasonable salaries but routinelyreinvested all after-tax earnings in the firm, so dividend policyhas not been an issue. However, before talking with potentialoutside investors, they must decide on a dividend policy. Your newboss at the consulting firm Flick and Associates, which has beenretained to prepare for its public offering and has asked you toaddress the following issues:
a. (1) What is meant by the term"distribution policy"? How has the mix of dividend payouts andstock repurchases changed over time?
b. Discuss the effects on distributionpolicy consistent with: (1) the signaling hypothesis (also calledthe information content hypothesis) and (2) the clienteleeffect.
c. (1) Assume that IWT has completed itsIPO and has a $112.5 million capital budget planned for the comingyear. You have determined that its present capital structure (80%equity and 20% debt) is optimal, and its net income is forecastedat $140 million. Use the residual distribution approach todetermine IWT's total dollar distribution. Assume for now that thedistribution is in the form of a dividend. Suppose IWT has 100million shares of stock outstanding. What is the forecasteddividend payout ratio?What is the forecasted dividend per share?What would happen to the payout ratio and DPS if net income wereforecasted to decrease to $90 million? To increase to $160million.
c. (3) What are the advantages anddisadvantages of the residual policy? (Hint: Don't neglectsignaling and clientele effects.)
e. Discuss the advantages and disadvantages of afirm repurchasing its own shares.
