Financial

Management 2

Assignment 1:
Dividend Policy
at FPL Group
GROUP 1

D I V YA N E G I ( M S 1 9 A 0 0 8 )

P R I YA N K A TA M B E
(MS19A060)
Why do firms pay dividends?

 Dividends are payments a firm makes to shareholders as a return on their investment. The
amount or frequency of payouts can show the strength of a company and its growth over
a given period. Not all companies pay dividends.

 Dividends send positive signals to the market indicating that the firm is performing well
and choose to give back the excess cash to the shareholders.

 This will also reduce the surplus the excess cash-flow available to managers, thereby
avoiding unnecessary spending.

 Generally, growth companies retain earnings while mature companies pay dividends.
Advantages and Disadvantages of paying Dividends

Advantages of paying dividends Disadvantages of paying

dividends
1. Investors prefer firms paying stable 1. Loss of clientele – Investors may sell of
dividends stock in short term
2. Firms can expect to avoid excess tax 2. When a company pays dividends, it
3. Temporary Excess Cash to avoid decreases its retained earnings
unnecessary spending (Agency Cost) 3. Reduction of usable cash which may limit
4. Reflects positively on the firm’s stability in the company’s growth.
the market (Financial Health) 4. Taxes are paid on the entire dividend are
higher as opposed to the capital gains tax
rates
Is the Dividend Irrelevance Theory applicable here?

Dividend Irrelevance Theory

The theory that investors do not need to concern themselves with a company's dividend policy
since they have the option to sell a portion of their portfolio of equities if they want cash.

Situation at FPL

 Due to the rise in deregulation and proposals of retail wheeling, the electric utility market has
become highly competitive. This leads to investors expectation and pressure towards high
dividends.

 Bond yields have increased whereas utility stock prices have decreased. Therefore, investors
must certainly be expecting returns in the form of dividends rather than opting to sell their
portion of equities for cash.

Hence, we can conclude that the Dividend Irrelevance Theory is not applicable here.
Most important issues confronting FPL Group in May
1994

 Lowering of the investment rating for the FPL group by Merrill Lynch
 California’s proposal to introduce retail wheeling will increase competition in the electric utilities
industry for FPL.
 Retail wheeling led to three largest utilities in California lose around $1.8 billion in market value
in 1 week.
 140 basis points increase in long term interest rate (Decreasing net income).
 The stock price fell by 19.6% from September 1993 to May 1994.
 Stock price fell by 6% in a single day.
 Ongoing lawsuit from the Florida Municipal Power Agency can have an impact on the firm’s
operations.
 S&P group announced a revision in its guidelines for evaluating investor owned electric utilities.
 High payout ratio in 1993 (461/429=107.46%).
From FPL’s perspective, is the current Payout ratio
appropriate? Would a higher/lower Payout ratio be
appropriate?
 The current Payout ratio for 1993 is 107.39%. This is highest payout ratio when compared to
other electric utilities.
 Maintaining the dividend at a constant rate (i.e. $2.48/share), the dividend payout ratio for the
year 1994 would be approximately
Payout Ratio90.12%.
- FPL Group’s Point Of View:

 From FPL’s perspective, the payout ratio is too high compared to the
industry. FPL will need additional funds in order to be prepared for the
changes facing the industry.

 They need to expand business operations and prepare for competition

as a result of retail wheeling will make it very difficult to maintain the
high payout ratio.

 By paying out a lower percentage, FPL could increase their potential

growth opportunities and place the company ahead of the competition,
which would ultimately improve the value of FPL for shareholders.
From an investor’s perspective, is FPL’s Payout
appropriate?

 With 51% share, Individual investors would not be

affected by any cut in payout for the reasons
mentioned below:
 Tax advantages of capital gains over income tax
rate
 Cut means there a prospective growth in the
future dividends
 The stock price may go up because of higher
growth rate
 Individual investors can use homemade dividends to
obtain capital gains.
 Institutions (36.9%) prefer high payout ratio in order
to earn higher profits.
What will the CEO James Broadhead do?

 He should first declare a cut in dividends. The dividend cut does not affect the majority of
its investors (individual investors – 52%).
 After the dividend cut is announced, the stock price may decrease, so FPL should use its
excess cash to buy back its shares to increase the stock price whenever it falls down.
 Then, FPL should repurchase its stocks and hold them regardless of market fluctuations.
This can help FPL increase its stock price irrespective of the dividend cut. This also allows
FPL to use its excess cash of $150 million.
 FPL should use its excess cash to invest more in high NPV projects, acquire new companies
and reinvest in financial assets.
 We can also see that the portion of industrial users among FPL’s investors is low. Since
industrial customers are the first to choose their electricity supplier, FPL should try to
attract more such investors. Even though FPL has a good hold in the individual investors,
acquiring industrial investors would be beneficial.
As Kate Stark, what would you recommend regarding
investment in FPL’s stock – buy/sell/hold?

 Investors should Hold the investment as even with a fixed dividend of $2.48 per share, the
company is expected to grow out of high payout ratio. 6% drop is expected reaction of the
market as some investors are speculative. This would also allow FPL to buy back its shares
even at fluctuating market prices, thus putting its cash to use.

 If there is a cut in dividend payout, Buy the stock. As cut means, the profits are going into
retained earnings for better future growth. Growing companies tend to pay lesser dividend
as they invest in high NPV projects.

 If the company decides to keep up with the current dividend payout, sell your share as there
will be high risk of defaulting if the same continues.