Case report for Linear Technology - Cash flow Essay Example
The main purpose of the report is to make a decision for Linear Technology on dividend policy - Case report for Linear Technology introduction. The report analyzed the impact of changing future dividend policy on the value of the company, based on its historical performance, financial history and market trends.
Linear Technology is a large-scale company which focus on the analog segments within semiconductor industry - linear technology case. It went public in 1986 and announced its dividend policy on 1992. Nowadays, under the market environment where dividends are unwilling to be paid, Linear still insisted its dividend commitment.
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Now Linear Technology is experiencing some difficulties with its profits that its quarter sales number in 2003 was far below that in last fiscal year, despite some growth. Changing dividend policy under such circumstances, therefore, will bring problems such as destroying investment opportunities and affecting executive stock options.
In order to seek solutions for Linear Technology, this report will balance pros and cons of dividend change. The main purpose of the analysis is to find out whether Linear Technology should increase its dividend payout.
Linear Technology’s Payout Policy
The payout policy of Linear Technology can be concluded into two elements: dividend payment and repurchase activities.
To maintain competitiveness, Linear paid a dividend for about 10 years. It first initiated a quarterly dividend of $0.00625 per share in 1993. The payout ratio is closer to 25% to 30% consistently during these years. Dividend yields various from 0.03% to 0.25% unevenly for the price per share is fluctuated. Dividend per share rises from $0.00625 in 1993 to $0.05 in 2003. And since 2000, the dividend begins to growth by $0.01 in every four fiscal quarters. During the decade, it seems Linear’s dividend policy goes less volatile, which may broaden the client base and somehow shows the desire of the company to be recognized as a more mature and confident.
Besides, the linear start to repurchase its stock intensively in 2001. The repurchases per year unevenly distributed from $0.06 to $0.36 in every fiscal quarter. This frequency in repurchase may be a signal indicates that manager view their stock price is undervalued.
What are Linear’s financing needs?
Linear’s capital expenditures remained under $40 million in most of years from FY1992 to the first quarter of FY2003, except in FY1996, FY2000, FY2001 in which the capital expenditures stood at relatively high level . Linear had positive net cash flows from FY1992 to the first three quarter of FY2003 and large cash balance, more than $1.5 billion in FY 2001, FY2002 and the first quarter of FY2003 respectively. The company should make a consideration on how to use and allocate the large cash balance to enable the company to sustain the well position in the industry and expand. Since the manager of the company did not plan to make acquisition and acted conservatively on exploring new business in Asia, the company need to find a balance way to allocate the cash to the shareholders. Should Linear return cash to its shareholders?
As Linear established positive cash flow and accumulated a large cash balance, the company should return cash to its shareholders. Linear has returned cash to its shareholders in forms of dividend and share repurchase. Offering dividend can not only help the company to show investors that Linear’s stock is less risky than other technology companies’ stock, but also show the company is confidence to keep growing in the future. Moreover, return cash to shareholders in form of dividend can broaden the company’s invest base, for instance attracting a new set of investors who had income goals in addition to growth goals. In other hand stock repurchasing is also a preferred way for Linear to allocate the cash to shareholders. One of the primary reason is that the company can offset the exercise of employee stock options. Another factor is that the company’s manager consider the return on cash balance: the interest rates have been so low that the cash was not earning much interest income. This encourage the Linear to use cash balance to buy back their shares. At last, Linear did not plan to make acquisitions and it had over $1.5 million cash and short-term investment in recent years.
Therefore Linear should return some cash to its shareholders due to the advantages discussed above. What are the tax consequences of keeping cash inside the firm? Linear would pay the corporate tax for earnings no matter the company chose to keep the cash or give it out. And if linear offered dividend, the shareholders had to pay for the dividend tax, meaning shareholders paid double taxes. Considering the proposal raised by President George W Bush in January 2003 that the taxes of dividends can be eliminate if they were paid out of earnings that had already been taxed and the capital gain tax is still required, the shareholders would benefit from saving dividend tax as if the company decided to offer dividend. Therefore the proposal would encourage the company to return cash to the shareholders. I would like to add sth. to your answer. Basically about why keeping money in the firm does no good. Please look at the content below and choose do or do not add these in the answer : ) If the cash is kept in the firm, there are chances that these capitals will be reinvested and bring the Linear Technology potential benefit from tax shield and interest earnings. Thus, a part of the opportunity costs of paying dividend will be a deduction of tax by the nature of debt investment. However, another factor that should be taken into account is the capital gains tax, meaning that the tax reduction from investing in debt is likely to be offset by the amount that capital gains are taxed. So, keeping the cash in the cooperation will not increase the profits. Change of company value if cash balance is all paid out
If Linear Technology decides to pay out all its cash balance to the investors, the value of the company will change in two phases after the decision has been made.
Once the announcement about how much dividend will be paid has been made, the price of the company will rise by the amount of the price. In this case, the original price was $30.87, with a dividend of $5.01, which means that the price of the company will rise to $35.88. The change of the stock price shows the expected gain of the investors once the dividend is paid.
However, at the ex-dividend day, the price will drop, usually to lower price than the original one. There are two underlying reasons for this phenomenon.
The first is a demonstration of a cash outflow from the company. The other is the loss of interest income brought by the payout. Due to the less interest income, the tax for income will be lower too, leading to a decline of stock price.
(The process of calculation will be seen on appendix)
Impact of repurchase shares
Generally speaking, repurchasing shares can largely decrease the systematic system. In this case, however, the main purpose of the repurchase activities is to offset the excise of options, which might dilute the price of the stock. Another reason for repurchasing is to avoid the high tax rate on the dividend. All in all, repurchasing might lead to a slightly lower stock price. (The process of calculation will be seen on appendix)
Why do firms pay dividends?
Even though dividends result in higher taxes, firms pay dividends mainly for three reasons. First, President Bush proposed a radical change to the taxation of investment income which hugely influenced the tax environment for dividends. It eliminated taxes on dividends if they were paid out of earnings that had already been taxed. This plan solved the double taxation problem of corporations to some degree, thus became an incentive for companies to pay dividends. Another reasons is that pay dividends is a signal of well operation and steady growth of the company. This would give investors an opportunity to generate income and then build up confidence in the company’s future. Therefore, more investors might be attracted to invest, providing more capital for use. Finally, as Blaine Rollins said that many mutual funds and European investment firms only buy stock with dividends, paying dividends could broaden the investor range for the company.
Why has the rate of dividend initiations changed over time?
The rate of dividend initiations is affected by many factors. To be more consice, conditions of market environment, expected dividend growth rate and expectation for the future financial position would all influence the rate of dividend initiations. Thus, it has changed over time according to the practical conditions. Recommendation for Linear Technology and the conclusion
It is recommended that Linear Technology should increase its dividend payment. Several advantages of increasing dividend are taken into account.
First of all, the future tax rate on dividend will be lower according to the proposal put up by president Bush. If the proposal is executed, there will be more payment than before due to the dividend increase and tax exemption, which is a piece of great news to the investors.
Secondly, the increase of dividend send a positive signal that the company is doing things well. Since profits of Linear Technology this quarter was far lower than that last year, an increase of dividend may help the investors regain faith to the company.
Last but not the least,, increasing dividend is also a good way to reduce agency costs. With large amount of cash balance in hand, managers’ control over the capital becomes larger. Paying dividend to the investors is an efficient way to get additional monitoring of the capital, and thus make it less attractive to managers to invest the money in projects that will reduce the benefits of the shareholders. Due to these three reasons, increasing the dividend may be an appropriate decision for Linear Technology under current circumstances.