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Dividend Assessment: The Cash - Trust Nexus

The document discusses dividend policy and how it relates to management trust and cash returns to shareholders. It provides a multi-step cash-trust assessment process to evaluate how much a company could have paid out in dividends versus what it actually paid out, and how much management can be trusted with excess cash based on investment performance and stock returns. It also introduces the concept of free cash flow to equity (FCFE) as a measure of how much a company can afford to pay out and provides examples of calculating FCFE for various companies.

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Anshik Bansal
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90 views

Dividend Assessment: The Cash - Trust Nexus

The document discusses dividend policy and how it relates to management trust and cash returns to shareholders. It provides a multi-step cash-trust assessment process to evaluate how much a company could have paid out in dividends versus what it actually paid out, and how much management can be trusted with excess cash based on investment performance and stock returns. It also introduces the concept of free cash flow to equity (FCFE) as a measure of how much a company can afford to pay out and provides examples of calculating FCFE for various companies.

Uploaded by

Anshik Bansal
Copyright
© © All Rights Reserved
Available Formats
Download as PDF, TXT or read online on Scribd
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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

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