Case Study On Warner Body Works

Presented by,
Minakshi Pathak
Moona Baral
Padam Shrestha
Pragati Dahal
Prathana Shrestha
Ravi Bhandari
Rithu Malekhu
Rubina Shrestha
Date:2013/04/23

Uniglobe collage of management (MBA 2nd)

BACKGROUND
Warner Body works is one of the leading producers of custom
coachwork for auto mobiles delivery trucks and other special
purpose vehicles.
Warner body works acquired a number of small firms engaged
in the research of robotics and material science as a move to
broaden its product line.
It has followed liberal dividend policy due to which most of its
stock holders are income-seeking rather than growth oriented.
Some argued that for the directors who owned large holdings of
Warner stock it would be more profitable to retain earnings.

CONTD..
Again it was argued that the company would loose the stock
holders who were interested in high dividends which would
lower their share price.
Looking at these arguments, the vice president of finance has to
come up with the most appropriate solution to tackle the issue.

Answer no.1
1. A CONTINUATION OF THE PRESENT POLICY OF PAYING OUT
60% OF THE EARNINGS.
Advantages:
Individuals, organization, social organization that need stable
income would prefer this policy as it provides a regular
dividend payment.
It minimizes uncertainty to investors as there is a regular
payment of dividend.
A regular dividend policy decrease agency costs by
reducing the free cash flow available to the managers of
the firm.
Thus as per policy, Warner Body Works current
stockholders is in support of high regular dividend.

CONTD
Disadvantage:
This policy would not be appropriate where the
companies have low free cash flow because they are
compelled to pay the regular dividend even if there are
no earnings.
They pay high dividends, so they to bear opportunity
cost of not investing in future projects.
The high payment of dividend leads to low current ratio
and increment of dividend.
If a firm pays out substantial dividends, it may need to
raise external capital at a later stage through the sale of
stock in order to finance the profitable investment
projects.

2. LOWERING THE PRESENT PAYOUT TO BELOW 60%

AND MAINTAINING THE PAYOUT RATIO RELATIVELY
CONSTANT AT THIS NEW FIGURE.

Advantages:
Lower dividend payouts can be preferred by individuals with
upper tax bracket , given the immediate tax liability, in favor of
higher capital gains with the deferred tax liability.
Low payouts can decrease the amount of capital that needs to be
raised, thereby lowering flotation costs.
As there is less need to raise external equity, controlling interest
of the stockholders will not be diluted.

Contd
Dividend earnings are less risky than capital gains and this will
help to reduce uncertainty.
With the reduction in the dividend payout, there is a risk that
the current income seeking investors would sell their stock.
Aggressive investors would more than take up that slack caused
by possible liquidation of income seeking investors, which
would result in the increase of the stock price if dividends were
cut.
Since high dividends hurt investors, while low dividends-high
retention help the firm's investors, low dividend stocks are more
valuable to the company.

CONTD
Disadvantages:
Lowering present payout below 60% might signal that
the firm is having financial difficulties. Hence the firm
has reduced its dividend payout.
Majority of the Current stockholders \ would sell their
stocks if the dividend payout ratio is reduced. This is
because they are in favor of stable growth rate than
growth potential.

3. A STABLE DOLLAR DIVIDEND POLICY

Advantage
Investors may use the dividend policy as a part for
information that is not easily accessible.
In the case of Warner Body Works this could be a better
option as the firm needs to retain its earnings to support
the acquisitions.
Disadvantage
Fluctuation of the dividend year to year leads to
investors to buy and sell stock to satisfy their current
needs.
Income seeking investors would sell the stocks as the
dividend income is uncertain.

4. LOW DIVIDEND PAYOUT AND SUPPLEMENTING

IT WITH EXTRA INCOME

Advantages:

This policy could be considered right if the firms

earnings are quite volatile.
If the firm does good earnings in some years, it may
pay extra dividends.
This policy ensures that the investors get a certain
minimum amount as dividend.
The investors have less expectation with this sort of
policy.
This sort of policy prevents negative signaling as there is
a pre fixed minimum limit for those investors who are
satisfied with the minimum level that is pre fixed.

CONTD..

Disadvantages:
There is an uncertainty in how much the investors are
getting as the dividend with this sort of policy; hence it
may not attract those parties who are seeking a stable
dividend.
The investors might think that the company has a weak
financial position, so it is going for a reduction in
dividend payout which may be a cause for negative
signaling to the investors.

ANSWER TO QUESTION NO:2

The advantage of announced dividend policy are:
Attracts investors:
o As the company is declaring a high dividend, many
companies would invest and thus it would lead the
company for expansion opportunities.
Reduces uncertainty
o The biggest advantage of having an announced dividend
policy is that it would reduce investor uncertainty.

CONTD
Reduction of cost of capital on future projects:
o Dividend payment will naturally reduce the present profit but
will definitely reduce the cost of future equity funding.
Disadvantages:
Difficult to alter the dividend policy once announced:
o It is difficult for the company to change its dividend policy
once announced because change in policy would incur high
cost.
Opportunity cost of reinvestment:
o As the company has already declared the dividend to its share
holders, now the company is compelled to pay the dividend .

CONTD.

Not suitable for unionized company:

The announced dividend policy is not suitable for
unionized company because it will lead to conflict
between the managers and the union.
Reduce credibility of the company:
In case if the company is not able to provide the dividend
to its shareholders that it had already declared then it will
hamper the reputation of the company in future.

Answer no.3
Table1: Calculation of ROE

1997

2005

Net Income(EAT)

31.2

104.3

Share holder's Equity

97.3

487

Return on Equity(ROE)

32.07%

21.41%

Here,
g = ROE*(1 - DPR)
Where, g = growth rate
ROE = Return on Equity ,
DPR = Dividend Payout Ratio
For 1997, g = 32.07(1-0.6)
= 12.826%
For 2005, g = 21.41%(1-0.6) = 8.56%

Contd.
In the above calculation for the year 1997 given an ROE of
32.07% and a dividend pay out of 60% the growth rate is
12.8326%
Likewise for the year 2005 when ROE is 21.41% and a
dividend pay out is 60% the growth rate in 8.56%

In the year 2005 the earning after tax has increased

proportionally lower in comparison to Share holder's equity
This shows the lower growth rate in earning per share when
dividend pay out ratio is constant @ 60%.

Answer no.4.
.Payout ratio identifies the percentage of net profit paid to stockholders in the
form of dividends, over a specified time frame. Dividend payout ratio
assesses the companys ability to sustain its dividend payments, and is
therefore useful predictors of continued profitability.
Selected Stock Market Data :
Particulars

Payout

P/E

Playboy

17%

25

Uniroyal

0%

19

Hewlett Packard

11%

17

Datapoint

0%

16

Texas instrument

30%

13

Xerox

40%

10

ATT

67%

Allied Stores

45%

Contd.
In the table companies having low payout ratio like Hewlett Packard
(11%) and Playboy (17%) have high P/E ratios
Companies having high payout ratios like ATT (67%) and Allied Stores
(45%) have low P/E ratios
However companies with payout ratio of(30%) and (40 %) have price
earning ratio of 13 times and 10 times
It is seen that even those firms that do not pay dividend have high P/E
ratios as compared to those who are paying dividends.
A low payout ratio represents a secure future, while a high ratio suggests
that a company has failed to reinvest its profits and may not be able to
sustain dividend payments.
For market with higher RE effect on MPS:
Low payout
High retention for more profitable project
increased MPS
high P/E
This in turn reduces the MPS and finally P/E ratio also declines.
Low payout
low profit
decreased MPS
low P/E

 price earning ratio and payout ratio both depicts the profitability
of the firm. So theoretically they should have direct relationship.
However the table shows the relatively inverse relationship.

Answer no. 5
Most organizations prefer to include certain portion of debt
capital in their capital structure.
More debt capital means more amount to be paid as interest as
well as loan.
With increased debt capital the firms are bound to several debt
contracts.
Use of high amount of debt capital will make creditors
reluctant to further provide loans.
Increased use of debt the return for equity shareholder would
be riskier.
In the case of Warner Body Works it has followed liberal
dividend policy.

ANSWERS NO.6
Opinion

of Mark Bassler is that a reduction in the

dividend payout rate would drastically reduce the
price of the stock.
His argument is based on the fact that majority
stockholders of Warner Body Works are incomeoriented investor.
Roger Murray, suggests that a reduction in the
dividend payout rate would incrssease the price of
the stock.
His argument is verified by the fact that if dividend
payout is reduced, income-seeking individuals
would most likely sell off their Warner stocks for
better paying stocks.

From the above evaluation of the two arguments, it can

be seen that Murrays argument has more weight than
that of Basslers.
Reduction in the dividend payout rate would mean that
the company can make acquisitions for cash.

QUESTION NO.7 MIGHT STOCK DIVIDENDS BE OF USE HERE?

A stock dividend is a dividend payment made in the form

of additional share to owners of the common stock
Transform of certain amount from the firms retained
earnings to capital stock account.
Benefits from stock dividend
Conservation of cash (Increase liquidity)
Tax benefits (70% tax on cash dividend & 28% on
Stock sell.)
To keep market price of a share within popular trading
range
Favourable psychological effect
Investment opportunity
Decrease in use of debt while financing capital

ANSWER NO. 8
Four alternative policies:
i)

A continuation of 60% dividend payout ratio

ii) Lowering the present payout ratio to some

20,30,40 percent)

percentage below 60%(i.e.

iii) Establishing a fixed dollar rate assuming the earnings will be

increased.

IV) SETTLING A RELATIVELY LOW DIVIDEND PAYOUT OF ONLY $0.50,

AND SUPPLEMENTING IT PERIODICALLY WITH EXTRA DIVIDEND THAT
WOULD DEPEND ON AVAILABILITY OF FUNDS AND THE NEED FOR
CAPITAL.

Here, the fourth policy of paying only $0.50 dividend is not

suitable.
Reason:
Most the stockholders of the organization are income
seeker who prefers high dividend payout ratio.

-JUSTIFY AMONG OTHER THREE ALTERNATIVES ON THE BASIS OF

GROWTH RATE AND ON EARNING PER SHARE
Table showing growth rate on various dividend policies
Dividend Payout
Dividend Policies

Retention Ratio Ratio

ROE

g%

40%

60%

21.42

8.57

DPR (20%)

80%

20%

21.42

17.14

DPR (30%)

70%

30%

21.42

14.99

DPR (40%)

60%

40%

21.42

12.85

48%

52%

21.42

11.44

First Dividend Policy

(favor of continuation of 60% dividend
payout ratio)
Second Dividend Policy
( favor of lowering the present payout
ratio)

Third Dividend Policy*

(favors establishing a fixed dollar rate)

HERE, MURRAY

SHOULD

RECOMMEND

SECOND

DIVIDEND POLICY, IN FAVOR OF LOWERING THE

PRESENT PAYOUT RATIO.

GROWTH RATE ON
PAYOUT IS ONLY

20%.

SINCE, THE
EPS 80% WHEN

HIGHEST
DIVIDEND

ANSWER NO. 9
The effect of these changes in optimal payout ratio further
calculation is done as shown in the table below.

Number of
share
Payout

Dividend in EAT

in

outstanding Average

policy

million

million

DPS

{million}

Stock Price

0.2

20.86

104.3

0.42

50

14.62

0.3

31.29

104.3

0.63

50

14.62

0.4

41.72

104.3

0.83

50

14.62

0.6

62.58

104.3

1.25

50

14.62

ANALYSIS OF THE CHANGES IN PAYOUT RATIO

As

such when tax rate is reduced to 50% the

stockholders will be benefited by (0.7*1.25 0.5*1.25)=$0.25.
reduction in capital gain also benefits the
stockholders by extra 8% in principal.
As a result stockholders prefer to earn through
capital gain or they seek for maximization of
shareholder's wealth through expansion and
growth.

CONCLUSION
Dividend policy is a very important tool for any
company.
Warner Body Works have avenues open for
expansion opportunities with relatively high returns .
It follows a liberal dividend policy of paying out 60%
of its earnings as cash dividends.
A higher debt in the capital structure would lead to
higher demand for dividend from the part of equity
holders.
Managers should focus on capital budgeting
decisions and ignore investor preferences.

LESSON LEARNT

The key lessons learnt from this case are:

Although a liberal dividend policy attracts investors, it is
not always beneficial for a company.
A company following residual dividend policy can make
acquisitions for cash rather than issuing new stock.
Stock dividends are better option than cash dividends.
The tax advantage of capital gains favors retention of
earnings.