Additionally, they repurchase stocks to offset the employee stock options that the company had as a large component of the employee compensation, which helped Linear in the years of low or slow sales. As stated in the case description, Linear has a strong cash flow as a company. In the basis of the financial needs for Linear Company, as a whole they need to make sure they are able to cover the executive stock option costs, as well as their capital investment In the fabrications facilities.
In the case It Is stated that Linear spent $200 million for new analog fabrication facilities, so therefore that expense would be a argue and Important financial need. Additionally, they need to keep some money set aside for expansion In the future. Since they don’t appear to be focusing on acquisitions at this point in time, they do not need to consider that in the financial needs, however if acquisitions do appear in the future they will be needed to take under consideration. Companies are supposed to drive value by growing the value of the company and the stock or by returning cash to shareholders.
In the case of returning case to shareholders, it would be recommended as long as it is in line with he future strategic growth plan. As far as this particular case, there is nothing that indicates a specific growth plan in the near future but it can be presumed to have some expansion in the future. Overall, it would be a good recommendation to return cash to shareholders as long as the executive stock options, fabrication Investments, and strategic growth plans for the future have all be met. A benefit to paying out cash to shareholders Is that It shows strength In the company as a whole.
By showing strength in the company, share prices in turn with will increase because investors eek higher dividends. Companies with higher dividends are seen are more valuable. A disadvantage to returning cash to shareholders is if Linear is unable to meet their dividend rate, they will be greatly punished and penalized causing their stock price to rapidly decrease. Additionally higher dividend means less cash in the business for future growth, which limits possible expansions in the future. In the terms of tax consequences, they should be relatively minimal since most of their investments are short-term investments.
Typically, in the business world, short-term investments usually only have a tax of 1-3% which is nominal compared to others. Linear would only be paying taxes on the cash on the Interest earned, which again will be relatively small. If Linear Technology were to pay out Its entire cash balance as a special dividend, they would increase their risk of financial distress costs by greatly tightening their The firm’s value would greatly decrease because by paying out the entire cash balance the company would be significantly diminishing their asset value.
As shown in Exhibit A, the overall value of this action would decrease the firm’s value by the total cash times the rate of interest: $1 * (1+3%) = $1 56,000. With the special dividend, Liner’s share price will increase by the amount of the dividend paid out. Therefore, with the number of shares outstanding at 312. 4 million, there will be an increase of $5. 01 [share as shown in Exhibit A. The current share price is $30. 87, so with the special dividend, share price will increase by $5. 10 to $35. 97/ share.
Although share price and the value incurs changes with the payout of the entire cash balance, earnings and earnings per share remain the same. Earnings and earnings per share are not affected by the dividend payout. Another option Linear Technology has to exercise its excess cash balance, they can repurchase shares to increase the value of the firm. This repurchase option is beneficial to the company and shareholders because in an open market share repurchase has no effect on the stock price. In addition, by repurchasing shares the firm’s earnings and earnings per share will increase.
As shown in Exhibit B, by calculating the total numbers of shares repurchased (total cash balance/price per hare) and subtracting it from the number of shares outstanding will give us the number of shares left outstanding after the repurchase to be 261 ,703,052. Exhibit B shows how this decrease in the number of shares drove up the earnings per share value by $0. 10 from $0. 55 to $0. 65. When the company repurchases shares instead of paying out in special dividends, the firm’s value will increase and it also allows the firm to retain its cash reserves within the company.
In general, companies pay dividends for a number of reasons. Dividends provide certainty about the company’s uncial well being. Many investors prefer the steady and secure income that comes with dividends and see dividends as strength in the company and a sign of future positive earnings. Dividend initiators tend to be large and stable firms with low growth rates but emit high profitability ratings. Typically a company is at the mature stage of their business cycles and in turn causes the company to generate a large amount of money in cash. Paul Cochlea should recommend to not raise the dividends but to initiate buybacks.
Linear already as higher dividends rates than all f its competitors. As a whole, the company 5 cents while Intel was only at 2 cents per share after the dividends were diluted. Also, if the company were to raise dividends, it would have to be at a level in which they could maintain for a long period of time and Linear does not have the extended amount of cash that Intel, Microsoft, and Cisco have and none of those companies have dividends at the level of Linear. Overall, Linear should do another stock buyback because earnings per share would increase since there will be fewer shares which will bump up the value of the stock.