DIVIDEND
ASSESSMENT:
THE
CASH-
TRUST
NEXUS
Dividend
policy
rests
on
management
trust.
Set Up and Objective
1: What is corporate finance
2: The Objective: Utopia and Let Down
3: The Objective: Reality and Reaction
The Investment Decision
Invest in assets that earn a return
greater than the minimum acceptable
hurdle rate
Hurdle Rate
4. Define & Measure Risk
5. The Risk free Rate
6. Equity Risk Premiums
7. Country Risk Premiums
8. Regression Betas
9. Beta Fundamentals
10. Bottom-up Betas
11. The "Right" Beta
12. Debt: Measure & Cost
13. Financing Weights
The Financing Decision
Find the right kind of debt for your
firm and the right mix of debt and
equity to fund your operations
Financing Mix
17. The Trade off
18. Cost of Capital Approach
19. Cost of Capital: Follow up
20. Cost of Capital: Wrap up
21. Alternative Approaches
22. Moving to the optimal
Financing Type
23. The Right Financing
Investment Return
14. Earnings and Cash flows
15. Time Weighting Cash flows
16. Loose Ends
36. Closing Thoughts
The Dividend Decision
If you cannot find investments that make
your minimum acceptable rate, return the
cash to owners of your business
Dividend Policy
24. Trends & Measures
25. The trade off
26. Assessment
27. Action & Follow up
28. The End Game
Valuation
29. First steps
30. Cash flows
31. Growth
32. Terminal Value
33. To value per share
34. The value of control
35. Relative Valuation
The
Cash/Trust
Assessment
Step
1:
How
much
could
the
company
have
paid
out
during
the
period
under
quesIon?
Step
2:
How
much
did
the
the
company
actually
pay
out
during
the
period
in
quesIon?
Step
3:
How
much
do
I
trust
the
management
of
this
company
with
excess
cash?
How
well
did
they
make
investments
during
the
period
in
quesIon?
How
well
has
my
stock
performed
during
the
period
in
quesIon?
3
How
much
has
the
company
returned
to
stockholders?
As
rms
increasing
use
stock
buybacks,
we
have
to
measure
cash
returned
to
stockholders
as
not
only
dividends
but
also
buybacks.
For
instance,
for
the
companies
we
are
analyzing
the
cash
returned
looked
as
follows.
Year
2008
2009
2010
2011
2012
2008-12
Disney
Dividends
Buybacks
$648
$648
$653
$2,669
$756
$4,993
$1,076
$3,015
$1,324
$4,087
$4,457
$15,412
Vale
Dividends
Buybacks
$2,993
$741
$2,771
$9
$3,037
$1,930
$9,062
$3,051
$6,006
$0
$23,869
$5,731
Tata
Motors
Dividends
Buybacks
7,595
0
3,496
0
10,195
0
15,031
0
15,088
970
51,405
970
Baidu
Dividends
Buybacks
0
0
0
0
0
0
0
0
0
0
0
0
Deutsche
Bank
Dividends
Buybacks
2,274
0
309
0
465
0
691
0
689
0
4,428
0
A
Measure
of
How
Much
a
Company
Could
have
Aorded
to
Pay
out:
FCFE
The
Free
Cashow
to
Equity
(FCFE)
is
a
measure
of
how
much
cash
is
lef
in
the
business
afer
non-equity
claimholders
(debt
and
preferred
stock)
have
been
paid,
and
afer
any
reinvestment
needed
to
sustain
the
rms
assets
and
future
growth.
Net
Income
+
DepreciaIon
&
AmorIzaIon
=
Cash
ows
from
OperaIons
to
Equity
Investors
-
Preferred
Dividends
-
Capital
Expenditures
-
Working
Capital
Needs
-
Principal
Repayments
+
Proceeds
from
New
Debt
Issues
=
Free
Cash
ow
to
Equity
Disneys
FCFE:
2008
2012
2012
Net Income
- (Cap. Exp - Depr)
2011
2010
2009
2008
Aggregate
$6,136
$5,682
$4,807
$3,963
$3,307
$604
$1,797
$1,718
$397
$940
$950
$23,895
$122
$4,638
- Working Capital
($133)
$308
($109)
$1,956
Free CF to Equity (pre-debt)
$5,665
$2,945
$2,139
$3,258
$3,294
$17,301
+ Net Debt Issued
$1,881
$4,246
$2,743
$1,190
($235)
$9,825
= Free CF to Equity (actual debt)
$7,546
$7,191
$4,882
$4,448
$3,059
$27,126
Free CF to Equity (target debt ratio)
$5,720
$3,262
$2,448
$3,340
$3,296
$18,065
Dividends
$1,324
$1,076
$756
Dividends + Buybacks
$5,411
$4,091
$5,749
$3,322
$1,296
$653
$648
$4,457
$19,869
Disney returned about $1.5 billion more than the $18.1
billion it had available as FCFE with a normalized debt
ratio of 11.58% (its current debt ratio).
6
EsImaIng
FCFE
when
Leverage
is
Stable
Net
Income
-
(1-
)
(Capital
Expenditures
-
DepreciaIon)
-
(1-
)
Working
Capital
Needs
=
Free
Cash
ow
to
Equity
=
Debt/Capital
RaIo
For
this
rm,
Proceeds
from
new
debt
issues
=
Principal
Repayments
+
d
(Capital
Expenditures
-
DepreciaIon
+
Working
Capital
Needs)
Thus,
whatever
debt
has
to
be
repaid
gets
paid
o
with
new
debt
and
addiIonal
debt
is
taken
on
to
fund
growth
in
the
rm.
An
Example:
FCFE
CalculaIon
Consider
the
following
inputs
for
Microsof
in
1996.
In
1996,
Microsofs
FCFE
was:
Net
Income
=
$2,176
Million
Capital
Expenditures
=
$494
Million
DepreciaIon
=
$
480
Million
Increase
in
Non-Cash
Working
Capital
=
$
35
Million
Debt
RaIo
=
0%
FCFE
=
=
=
Net
Income
-
(Cap
ex
-
Depr)
(1-DR)
-
Chg
WC
(!-DR)
$
2,176
-
(494
-
480)
(1-0)
$
2,127
Million
-
$
35
(1-0)
By
this
esImaIon,
Microsof
could
have
paid
$
2,127
Million
in
dividends/stock
buybacks
in
1996.
They
paid
no
dividends
and
bought
back
no
stock.
Where
will
the
$2,127
million
show
up
in
Microsofs
balance
sheet?
8
FCFE
for
a
Bank?
We
redene
reinvestment
as
investment
in
regulatory
capital.
FCFEBank=
Net
Income
Increase
in
Regulatory
Capital
(Book
Equity)
Consider
a
bank
with
$
10
billion
in
loans
outstanding
and
book
equity
of
$
750
million.
If
it
maintains
its
capital
raIo
of
7.5%,
intends
to
grow
its
loan
base
by
10%
to
$11
billion
and
expects
to
generate
$
150
million
in
net
income:
FCFE
=
$150
million
(11,000-10,000)*
(.075)
=
$75
million
Deutsche Bank: FCFE estimates (November 2013)
Asset Base
Capital ratio
Tier 1 Capital
Change in regulatory capital
Book Equity
ROE
Net Income
- Investment in Regulatory
Capital
FCFE
Current
439,851
16.00%
70,376
76,829
1
453,047
16.00%
72,487
2,111
78,940
2
466,638
16.00%
74,662
2,175
81,115
3
480,637
16.00%
76,902
2,240
83,355
4
495,056
16.00%
79,209
2,307
85,662
5
509,908
16.00%
81,585
2,376
88,038
-1.08%
-757
0.74%
584
2.55%
2,072
4.37%
3,642
6.18%
5,298
8.00%
7,043
2,111
-1,528
2,175
-102
2,240
1,403
2,307
2,991
2,376
4,667
Dividends
versus
FCFE:
Across
the
globe
Figure
11.2:
Dividends
versus
FCFE
in
2014
70.00%
60.00%
50.00%
FCFE<0,
No
dividends
40.00%
FCFE<0,
Dividends
FCFE>0,
FCFE<Dividends
30.00%
FCFE>0,
No
dividends
FCFE>0,FCFE>Dividends
20.00%
10.00%
0.00%
Australia,
NZ
and
Canada
Developed
Europe
Emerging
Markets
Japan
United
States
Global
10
Chrysler: FCFE, Dividends and Cash Balance
The
Consequences
of
Failing
to
pay
FCFE
$3,000
$9,000
$8,000
$2,500
$7,000
$2,000
$5,000
$1,000
$4,000
Balance
$1,500
Cash
Cash
Flow
$6,000
$3,000
$500
$2,000
$0
1985
1986
1987
1988
1989
1990
($500)
1991
1992
1993
1994
$1,000
$0
Year
11
6
ApplicaIon
Test:
EsImaIng
your
rms
FCFE
In
General,
If
cash
ow
statement
used
Net
Income
+
DepreciaIon
&
AmorIzaIon
-
Capital
Expenditures
-
Change
in
Non-Cash
Working
Capital
-
Preferred
Dividend
-
Principal
Repaid
+
New
Debt
Issued
=
FCFE
Net
Income
+
DepreciaIon
&
AmorIzaIon
+
Capital
Expenditures
+
Changes
in
Non-cash
WC
+
Preferred
Dividend
+
Increase
in
LT
Borrowing
+
Decrease
in
LT
Borrowing
+
Change
in
ST
Borrowing
=
FCFE
Compare
to
Dividends
(Common)
+
Stock
Buybacks
B
FA
page
PB
Page
44
12
Task
EsImate
the
potenIal
dividends
for
your
company
and
its
current
cash
balance.
13
Read
Chapter
11
