MBA 702 Linear Case Questions

docx

School

North Dakota State University *

*We aren’t endorsed by this school

Course

702

Subject

Finance

Date

Apr 3, 2024

Type

docx

Pages

Uploaded by HighnessSteel1477

Linear Case Questions by Jayden Roos 1. Describe Linear Technologies payout policy. Due to the favorable profit situation and optimistic future expectations, Linear Technologies started paying quarter dividends in 1992 at $0.05 per share. The initial low- dividend policy was explained by the “dividend stickiness” phenomenon and the possibility of keeping a sustainable dividend level over time. In 1994 the payout ratio amounted to 15% of earnings. Despite a drop in sales and earnings, the company held the strategy of gradual dividend increase. The main arguments in support of this strategy were: to build confidence in existing investors and by doing that distinguish themselves from riskier payout strategies in other technology companies, to attract new investors who are pursuing income goals, and to meet the demand from Mutual funds and European investment firms that will only buy stocks with dividends. During the following years, the payout ratio reached 25 to 30%. In addition to paying dividends, the company participated in share repurchases in some years. The main motives that encouraged the company to buy back were an offset of employees’ stock exercise and better use of excess cash due to low interest rates. Linear Technologies is regarded to be a relatively high dividend payer in comparison with other companies in the technology industry. Nevertheless, this dividend policy is consistent with the maturity stage the company falls within. Neither investment nor acquisitions were considered. To sum it up, Linear Technologies' dividend policy is to provide sustainable long-run dividends and target investors that prefer dividend income instead of seeking capital gains from growth opportunities. 2. What are Linear’s financing needs? Should Linear return cash to its shareholders? What are the tax consequences of keeping cash inside the firm? Linear has low financing needs. Despite of economic downfall, Linear's net income and net cash flow were positive from 1992 to 2003. Its cash and short-term investments reached their peak in the early 2000s, going up to $1.5B. The CFO also made it clear that there would be no plans for acquisitions, showing that the investment plans, strategies, and cash flow of the company were well handled. While semiconductor companies tend to have inevitably expensive investments related to R&D due to its nature, Linear Technologies was able to reduce costs by investing heavily in analog fabrication facilities. In addition, Linear technology was looking at investment opportunities in Asia, but George Bush’s declaration of war in Iraq in 2003 was raising uncertainties in the global economy. It can be assumed that the desire to raise additional funds would not have been great at a time when uncertainties about real investment are gradually growing. Returning cash to its shareholders may have advantages, but this does not mean it is to be done by more dividend payouts. Some positive sides of giving out dividends are: 1. assuring opportunities for new investors. and 2. being able to prove to investors that the company has positive aspects also with lower risk when compared to other technology companies. It also reduces agency conflicts because paying out dividends to investors will allow them to have additional monitoring over capital. Stock repurchasing is another good way to

allocate cash to shareholders. It was a method to offset the exercise of employee stock options and compensate for the low interest rates It can increase EPS and share prices by reducing outstanding shares and lowering the burden of high dividend tax. Though these are positive effects of returning cash to its shareholders by giving out dividends or repurchasing stocks, there are some negatives. As increasing dividend payments shows the company's potential growth, its 'stickiness' makes it difficult to change later. Furthermore, the drop in the net income and net cash flow in 2002 and 2003 shows that Linear is sensitive to the market. Market reaction sensitivity and inflexibility of dividend payments are the reasons why there should be a limit on returning cash to shareholders. At that time, there were a lot of surplus cashable assets in Linear Technology. If the reserved cash accumulated in the company was not processed through investment opportunities, it could adversely affect shareholders in the market, so from the perspective of Linear technology, it would be assumed that there was pressure on payout at the time. The impact of taxes on companies holding surplus cash can be largely divided into two major parts. First, it is more taxation on surplus cash holdings, and the rest is an increase in shareholders' dividend demands due to a decrease in dividend income tax. The first is due to the presence of the Accumulated Earnings Tax (AET), which was applied to most companies in the United States. The AET system excludes the part of the net profit that can be reserved for business, and if the rest is not paid out or invested, 15% is taxed. Second, the situation in the United States at the time, and in 2003, George Bush announced a plan to abolish the dividend income tax. Although it decreased by only 15%, it can be thought that this had a great influence when discussing dividend payments at the general shareholders' meeting. 3. If Linear were to pay out its entire cash balance as a special dividend, what would be the effect on value? On the share price? On earnings? On earnings per share? What if Linear repurchased shares instead? Assume a 3% rate of interest. Special Dividend (all in millions)  # of shares: 312.4  Share value: $30.87  Market value (millions): $9643.79  Earnings Per Share: Net Income/ # of shares = 170.6/312.4 = $0.55  Special Dividend Paid: Cash and Short-Term Investments / # of shares = 1565.2 / 312.4 = $5.01  New Share Price: Share value – Special Dividend Paid = 30.87 – 5.01 = $25.86  New outstanding shares: 312.4  Loss of interest income: Cash and Short-Term Investments * rate of interest = 1565.2 * 3% = $46.95  EBIT = $240.30

 New Earnings: EBIT – (EBIT – Loss of interest income) * 29% = 240.30 – (240.30 – 46.95) * 29% = 240.30 – 193.35 *29% = 240.30 – 56.07 = $184.23  New Earning per share: New Earnings / # of shares = 184.23 / 312.4 = $0.59 Repurchase (all in millions)  # of shares: 312.4  Share value: $30.87  Market value: $9643.79  Earnings Per Share: 170.6 / 312.4 = $0.55  # of Shares repurchased: Cash and Short-Term Investments / Share value = 1565.2 / 30.87 = 50.7  New outstanding shares: # of shares - # of shares repurchased = 312.4 – 50.7 = 261.7  New Share Price: Market value / new outstanding shares = 9643.79 / 261.7 = $36.85  Loss of interest income: 1565.2 * 3% = $46.95  EBIT: $240.30  New Earnings: 240.30 – (240.3 – 46.95) * 29% = $184.23  New Earning Per Share: 184.23 / 261.7 = $0.70 4. Why do firms pay dividends? Why has the rate of dividend initiations changed over time? Firms pay dividends to distribute profits to shareholders as a reward for their investment in the company. Dividends are a way for companies to share their financial success with their shareholders by providing them with a portion of the company’s earnings. Paying dividends can attract investors who are seeking regular income from their investments and can also signal to the market that the company is financially stable and generating consistent profits. Additionally, paying dividends can help maintain shareholder loyalty and confidence in the company’s performance. The rate of dividend initiations has changed over time due to various factors such as shifts in market conditions, changes in investor preferences, and evolving corporate finance practices. In the past, companies were more inclined to pay dividends to attract investors and demonstrate financial stability. However, in recent years, there has been a trend toward companies retaining earnings for reinvestment in growth opportunities rather than distributing them as dividends. Moreover, some companies may choose not to initiate dividends due to tax implications, preferring instead to use other methods such as share buybacks to return capital to shareholders. Changes in regulatory environment, economic conditions, and industry trends can also influence the decision of firms to initiate or increase dividend payments.

Your preview ends here

Eager to read complete document? Join bartleby learn and gain access to the full version

Access to all documents
Unlimited textbook solutions
24/7 expert homework help

5. What should Paul Coghlan recommend to the board? Coghlan should suggest maintaining or decreasing its dividend. The IT bubble is coming to an end, and it should consider the irreversible characteristic of dividend policy. Looking at the Utilities, the whole Tech industry's ROE is lower than high tech industries due to high dividend yield. High dividends give negative signals to the market which leads to a decline in corporate value. Even though Linear Tech is doing well in this situation, it should keep its cash in case of unwanted situations, and current economic situations should be considered carefully. Although the company is yet without clear investment projects for later, such as considering whether to invest firmly in Asia, it is recommended to repurchase rather than issue dividends for shareholder returns. Additionally, as mentioned, since Linear Tech already has high dividend yield levels in its industry, there is no big pressure to increase dividends now. Also, holding cash can maintain the company's high credit rating. If there's a bigger demand than now from shareholders to return cash, Linear Tech can use the method of repurchasing or special dividends, which are more flexible because of their discretionary nature. Therefore, rather than returning all the cash it holds, it should keep a certain portion of cash for the post-investment opportunity and do repurchase for the return plan.