Data Case for Chapter 17: Payout Policy
In your role as a consultant at a wealth management firm, you have been assigned a very powerful client who holds one million shares of Cisco Systems, Inc. purchased on February 28, 2003. In researching Cisco, you discovered that they are holding a large amount of cash. Additionally, your client is upset that the Cisco stock price has been somewhat stagnant as of late. The client is considering approaching the Board of Directors with a plan for half of the cash the firm has accumulated, but can’t decide whether a share repurchase or a special dividend would be best. You have been asked to determine which initiative would generate the greatest amount of money after taxes, assuming that with a share repurchase your client would keep the same proportion of ownership. Because both dividends and capital gains are taxed at the same rate (15%), your client has assumed that there is no difference between the repurchase and the dividend. To confirm, you need to “run the numbers” for each scenario.
1. Go to http://finance.yahoo.com, enter the symbol for Cisco (CSCO), and click “Key Statistics.”
a. Record the current price and the number of shares outstanding.
b. Click on “Balance Sheet” under “Financials.” Copy and paste the balance sheet data into Excel.
2. Using one-half of the most recent cash and cash equivalents reported on the balance sheet (in thousands of dollars), compute the following:
a. The number of shares that would be repurchased given the current market price.
b. The dividend per share that could be paid given the total number of shares outstanding.
3. Go to http://finance.yahoo.com to obtain the price at which your client purchased the stock on February 28, 2003.
a. Enter the symbol for Cisco and click “Get Quotes.”
b. Click “Historical Prices,” enter the date your client purchased the stock as the start date and the end date, and hit “Enter.” Record the adjusted closing price.
4. Compute the total cash that would be received by your client under the repurchase and the dividend both before taxes and after taxes.
5. The calculation in Step 4 reflects your client’s immediate cash flow and tax liability, but it does not consider the final payoff for the client after any shares not sold in a repurchase are liquidated. To incorporate this feature, you first decide to see what happens if the client sells all remaining shares of stock immediately after the dividend or the repurchase. Assume that the stock price will fall by the amount of the dividend if a dividend is paid. What are the client’s total after-tax cash flows (considering both the payout and the capital gain) under the repurchase of the dividend in this case?
6. Under which program would your client be better off before taxes? Which program is better after taxes, assuming the remaining shares are sold immediately after the dividend is paid?
7. Because your client is unlikely to sell all 1 million shares today, at the time of dividend/repurchase, you decide to consider two longer holding periods: Assume that under both plans the client sells all remaining shares of stock 5 years later, or the client sells 10 years later. Assume that the stock will return 10% per year going forward. Also
assume that Cisco will pay no other dividends over the next 10 years.
a. What would the stock price be after 5 years or 10 years if a dividend is paid now?
b. What would the stock price be after 5 years or 10 years if Cisco repurchases shares now?
c. Calculate the total after-tax cash flows at both points in time (when the dividend payment or the share repurchase takes place, and when the rest of the shares are sold) for your client if the remaining shares are sold in 5 years under both initiatives. Compute the difference between the cash flows under both initiatives at each point in time. Repeat assuming the shares are sold in 10 years.
8. Repeat Question 7 assuming the stock will return 20% per year going forward. What do you notice about the difference in the cash flows under the two initiatives when the return is 20% and 10%?
9. Calculate the NPV of the difference in the cash flows under both holding period assumptions for a range of discount rates. Based on your answer to Question 8, what is the correct discount rate to use?
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