Dividend policy at Linear

Technology
FA Assignment Sec-C
Submitted by: Satyajeet Sahoo 2010PGP342
Executive Summary
Linear technology is a leading player of analog devices. It was one of the first technology
companies to start paying out dividends. Initially the dividend amount was just token as it
believed that investors don’t want companies to reduce their dividends so having a token
dividend meant that they could sustain it for longer periods. It is currently having excess
cash of $1.5 billion which could be utilized by them to finance new fabrication facilities that
require an investment of $200 million which would enable them to continue innovating and
expanding into new markets.

Now, the CFO Paul Coghlan is pondering over the following options:

1. Re-adjusting the dividend (increasing),

2. Repurchase of their shares with the cash.
3. Finance new fabrication facilities

The decision needs to take into account – benefits to the company and to the shareholders.
Paying dividend reduces the firm value by reducing the assets. On the other hand
repurchase causes the EPS to rise. This increase in the EPS leads to share price appreciation.
With respect to paying dividend the company strategy was to be very conservative by
setting it at a low level initially so that it will be able to match the expectations of the
shareholders.

By paying dividends the company will form a positive image with the shareholders. It will
also attract the investors that prefer companies that pay dividend. But will also result in tax
on dividend amount to shareholders. This tax can be deferred by going for the repurchase
decision, which can result in capital gains to the shareholders. Another alternative is to
reinvest the cash to build fabrication facilities, but that is not recommended at this time as
the growth is slowing down. This can be explored later once the recessionary trend changes
to growth.

Option 1 – Paying Dividends

Benefits

1. Gives positive signal to the market

2. Cash dividends shares sell at a premium
3. Capital gain is not always certain
4. Reduces the cash flow available to the managers thereby reducing the conflict
between the shareholders and the company
5. Dividends do not signify a reduction on earnings
6. Shareholders are delighted
7. Attracts investors that prefer companies that pay dividend
Shortcomings

1. Dividends are taxed, which shareholders would not like

2. Some shareholders might be more interested in capital gains than dividend gains. As
the capital gains are more substantial.

Tax Consequences of Dividends (All figures are in $Million)

Outstanding New Total Total Tax Paid
Shares Dividend Dividend
Paid
312.4 0.04 12.496 1.8744
312.4 0.045 14.058 2.1087
312.4 0.05 15.62 2.343
312.4 0.055 17.182 2.5773
312.4 0.06 18.744 2.8116

Option 2 – Repurchase shares from market

Benefits

 Increased EPS – increased shareholder value

 Higher stock prices – capital gains
 Deferred income taxes (on realized capital gains)
 Reduces future dividend liability
 Displays confidence of the firm in itself

Shortcomings

 There is executional delay between announcing a buyback and executing it. On

hearing the announcement of repurchase, the price of the shares can jack up in the
window between the announcement and the repurchase. This can lead to
repurchased shares being costlier than the original shares and thus lesser number of
shares will be repurchased.
 Comparing the two options

The two options can be compared by comparing the change in the stock prices effected

Cash paid Divide New

as Tax nd per Dividend Share Change
dividend paid share received Price in value
Dividend 1565.2 234.78 5.01 4.2585 26.61 1330.42
Cash No. of No. of Net Net P/E (for Change
used for shares outstan Income Income EPS (for 2003 as New in Value
repurcha repurc ding (for (for 2003 at referen Price of of the
se hased shares 2002) 2003) 3%) ce) Share firm
Repurchase 1565.2 50.7 261.7 197.6 231.9 0.89 56.534 50.1 3466.47
For 7 % growth rate 233.95 0.89 50.54 3582.34

Conclusion
Thus from the above analysis we can see that it is more beneficial for Linear Technology to
use its excess cash for share repurchase as it adds more value to the firm and leads to
increase in the price of the stock which is additional motivation for the employees. Dividend
payment would have a negative effect in terms of the value of the form and the stock price.
In addition from the tax rate perspective also it is beneficial for the investors and the firm
that Linear Technology maintains its current dividend ratio.

Also, since Linear has excess cash, it can set aside some money for investment into new
fabrication facilities. Since the fabrication facilities of analog devices cost only $200 m, so
this can be easily financed from the current cash reserves. The benefits of the new
fabrication facilities wont be felt immediately but will have an impact in the future.