Integrated Waveguide Technologies Preparing for a Public Offering Essay

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Introduction

Distribution policy is a set of principle stipulating the guidelines for cash dividends payout to the shareholders and stock repurchases. Dividends mean the company's earnings distributed to the stockholders declared during the year, interim dividends, or at the end of a financial year referred to as the final dividend. Dividends account as a source of income for the investors but also have an information signaling effect. Therefore, a dividend distribution is informing the management of the earnings to allocate as dividends and contribute to sharing purchase investment decisions. Dividend distribution policy is informed by multiple factors such as financial flexibility, investment opportunities for the company, tax consideration, contractual and legal restrictions, the volatility of expected future earnings, and flotation costs (Baker & Weigand, 2015).

Dividends may be distributed in the form of stock repurchases or cash dividends. Cash dividends offer investors a stream of income. Stock repurchases entail the buyback of a firm shares. Stock repurchases are employed as a strategy for managing a company's real earnings. Moreover, the stock repurchases have an inverse relationship with the EPS. The dividend distribution policy ought to be stable to ensure investor confidence. Therefore, management faces the tradeoff of adopting a capital budgeting decision to lower dividends and use the resources for new investment, which potentially decreases the stock prices or the undertake borrowing to pay dividends that result in a stock price increase (Travlos et al., 2001).

According to Farre-Mensa et al. (2014), the stock repurchases have replaced cash dividend payouts as the prime distributor of a firm's earnings. Skinner (2007) observes that over the decades, the earnings and payout have evolved, yielding three principal categories of firms; firms that make regular stock repurchases and pay dividends, firms that undertake regular stock repurchases, and firms that undertake occasional repurchases with firms that pay dividends exclusively are largely becoming extinct. Stock repurchases have been identified to boost earnings per share, a tax-efficient approach of returning excess capital to investors since the stock repurchases incur capital gains tax. In contrast, the dividend income is taxed as ordinary income. Stock repurchases signal a stock undervaluation, which enables the managers not to pursue unsustainable firm growth, which potentially impacts the long-term profitability and value of the firms negatively (Farre-Mensa et al., 2014).

Dividend Policy Theories

Dividend policy literature has produced a diversified theoretical foundation with foundations on the concept of dividend relevance, capital gains, and the tax and transaction cost indifference (Baker & Weigand, 2015). According to Mohanasundari & Vidhya (2016), the founding theories are premised on the correlation between dividend payment and firm value.

Dividend irrelevance theory

The Modigliani- Miller (MM) dividend irrelevance theory contends that a firm's value is independent of the dividend policy; hence a company's declaration of dividends has no adverse effect on the stock prices. Modigliani and Miller posit that a firm's value is determined by the basic earning power and its business risk instead of the pattern of income distribution between retained earnings and dividends. The theory is premised on the assumption that firms operate on the perfect capital market of the absence of transaction costs and capital gain taxes (Al-Malkawi et al., 2010).

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Systematic analysis of the literature by Mohanasundari & Vidhya (2016) identifies that the MM dividend irrelevance theory is founded on a perfect capital market concept while, in reality, markets are imperfect. Empirical analysis by Black & Scholes (2010) of a portfolio of 25 common stock listed on the New York Stock Exchange identified no causal relationship between dividend yield and stock returns, which are consistent with the dividend irrelevance theory. However, subsequent empirical analysis has demonstrated a positive relationship between stock prices and dividend policy, with stock prices rising with the cash dividend (Travlos et al., 2001).

Dividend preference theory/Bird-in-Hand Theory

Myron Gordon (1963) and John Litter (1964) proposed that the dividend preference theory posits that investors are risk-averse and indifferent between capital gains tomorrow and dividends today. Consequently, investors prefer stocks characterized by high and…

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…implying the firm ought to maintain the target growth, which could be achieved by revising the capital structure when inevitable.

Question 8: Stock Repurchase

Stock repurchases mean the buying of a firm's stock from the stockholders. Stock repurchases are adopted as large capital restricting strategy, alternative means of distribution of earnings as opposed dividends, or as a means of disposal of one-time cash earned from the sale of an asset.

Question 9: Advantages and Disadvantages of Stock Repurchases

A fundamental advantage of stock repurchases is that firms can avoid setting unsustainable dividends. Repurchased stocks are conveniently resold to raise capital. Distribution of excess cash through stock repurchase enables the reduction of agency costs. The stock repurchase is conceived as a management signal to the investors that the stock is overvalued, implying that the stock prices will increase. A stock repurchase implies that investors earn capital gains with lesser tax liability than dividends that have a higher tax liability. Moreover, stock repurchase is voluntarily implying that the stockholder could choose to or not to resell the stock, but cash dividends are obligatory.

Firm would need to bid higher than the prevailing stock price to attract a complete repurchase, hence higher cost implication. Firms would risk penalty imposition by The Internal Revenue Service (IRS) if the stock repurchases were a tax avoidance strategy. The stockholder's risk being unfairly treated due to information inadequacy.

Question 10 & 11: $50 Priori Distribution value of equity and Per Stock Price

· Intrinsic Value of Equity = (Value of Operations Short Term Investment – Debt)/Number of shares: ($1937.5Million $50 Million - $387.5 Million) = $1600 Million

· Intrinsic Per Share Stock Price = $1600M/100M = $16

Question 12: $50 Post Distribution Intrinsic Per Share Price

· IWT's intrinsic value of equity = $1937.5Million - $387.5 Million = $1550 Million

· Intrinsic per share stock price = $1550Million/100Millioin = $15.5

· The $50 million distribution results in a $0.5 drop-in….....

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