DIVIDEND POLICY AT FPL
GROUP 20:Assignment 1
Madhu Jethani MS19A070
Priyanka Azad MS19A072
WHY DO FIRMS PAY DIVIDEND?
To reward their shareholders for providing them capital to
run their business.
To balance their asset and capital structures when their
earnings outstrip their investment opportunities.
To mitigate agency problems when they have excess
earnings.
Dividend payment is important for investors because
company’s dividend policy helps them determine the
soundness of firms’ financial well being
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ADVANTAGES OF DIVIDEND PAYMENTS
Shareholder’s perspective Firm’s perspective
Little or no dividend payout is more • A dividend policy is irrelevant or
favorable for investors because has no impact on the firm’s value
taxation on dividend is higher than
• Dividend payments can reduce
tax on capital gains
internal source of financing
Dividends are taxed as ordinary
• Once established, dividends cuts
incomes
are hard to make without
Reinvesting dividends will usually
adversely affecting a firm’s stock
leave an investor with less
price
shareholder equity than they would
have had if dividends were not paid. • Cash paid out to investors cannot
be used to grow the business.
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DISADVANTAGES OF
DIVIDEND PAYMENTS
Shareholder’s perspective Firm’s perspective
Little or no dividend payout is more • A dividend policy is irrelevant or has
favorable for investors because taxation no impact on the firm’s value
on dividend is higher than tax on capital
• Dividend payments can reduce
gains
internal source of financing
Dividends are taxed as ordinary incomes
• Once established, dividends cuts are
Reinvesting dividends will usually leave
hard to make without adversely
an investor with less shareholder equity
affecting a firm’s stock price
than they would have had if dividends
were not paid. • Cash paid out to investors cannot be
used to grow the business.
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DIVIDEND IRRELEVANCE THEORY
The Dividend Irrelevance theory argues that the dividend
policy of a company is completely irrelevant. The market
price of the shares is not affected by dividend policy.
Payment of dividend does not change the wealth of the
existing shareholders because payment of dividend
decreases cash balance and their share price falls by that
amount.
In FPL’s case, Dividend Irrelevance theory is not applicable
to individual investors (51.9%).
Decreasing the payout ratio will reduce the stock price of
the firm.
It will affect institutional investors(36.9%) who seek higher
returns in the form of dividends.
Majority of shareholder’s being individual investors this
theory does not apply to FPL
Lastly, one of the assumptions of this theory is Earnings of
the firm are perpetual and future earnings are known. In
FPL’s case, Future earnings are uncertain owing to
forthcoming potential competition
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ISSUES CONFRONTING FPL GROUP IN MAY 1994
Authorization of
retail wheeling
Fall in stock
Settlement of Rising interest proposal by
Suggestion of price by 19.6%
Lower lawsuit rate and utility
dividend cuts by and decrease in
investment rate between FPL decreasing net commission
FPL’s managers S&P index by
and FERC income would lead to
22.1%
potential
competitors
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CURRENT PAYOUT
RATIO- FPL’S PERSPECTIVE
• FPL has the highest payout ratio in
comparison to other electric utilities in the
same industry.
• FPL considers its payout ratio to be too
high
• A lower payout ratio will be appropriate-
Cash can be used to meet future
uncertainties
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APPROPRIATE PAYOUT RATIO & INVESTOR’S PERSPECTIVE
For institutional investors(36.9%), high payout ratio may be appropriate as they seek
higher earnings. If FPL tries to maintain this ratio, it can satisfy those small investors but it
has to increase this ration over time to satisfy these investors’ expectation.
For individual investors(51.9%), payout ratio has little meaning, capital gains are more important
to them. According to the Miller-Modigliani theory, dividend policy should not matter since
the returns that investors would earn would be the same as the return that the firm
would receive if the cash were reinvested. Furthermore, they do not need dividends to convert
shares to cash. FPL’s decision to cut payout ration does not really affect the value of these
individual investors.
Our opinion- FPL is maintaining an inappropriate ratio. It should lower the ratio(below
industry’s average) to prepare for potential competition in the future and use excess cash make
more investments for sustainable growth
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SUGGESTIONS FOR CEO
JAMES BROADHEAD
Cut dividends(payout ratio).
Should not worry about the lawsuit against the its dividend policy as the reduction in payout
ratio does not affect the majority investors(individual)
After declaring dividend cut- stock price might decrease . The company can use its excess
cash and go for repurchase/buy-back of shares to increase the stock price whenever it falls
down.
FPL should use Buy and Hold strategy to repurchase its stocks and hold them regardless of
market fluctuations. This solution as a long term investment can help FPL increase its stock
price which has fallen in early 1994. By doing so, FPL can get rid of its excess cash of $150
million per year.
FPL also can use this strategy to increase incentive compensation by granting stock options
to employees and thus, increase employment commitment and recruiting attractiveness to
have competent personnel for future growth.
FPL should use its excess cash to invest more and prepare for forthcoming competition by
investing in new profitable projects, acquiring new companies and profitable assets, and
reinvesting in financial assets.
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BUY/SELL/HOLD
Kate Stark should recommend Holding the shares
currently
Watch out for future prospects of FPL and announcements
by FPL’s Directors
After company announces its decision on dividend policy-
Payout ratio reduces- Buy
Stock price might reduce but it can be corrected by firm Payout ratio remains same- Sell
through share repurchase • Merril Lynch’s report highlights inappropriate high dividend payout
High growth prospects of the firm ratio of FPL
• FPL to get affected by the forthcoming deregulation in the market
As it can be seen below, FPL’s profitability in 1993 is equal • 6% drop reaction expected in the market due to some speculative
or more than industry’s average investors
• Risk of default if current payout ratio continues
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FPL’S ESTIMATED PERFORMANCE OVER YEARS
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THANK YOU
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