4 / 12 | 67% + >> Scenario A: Pay Out One-Third of the Earnings as a Dividend and Reinvest the Remaining Two-Thirds This scenario reflected the preference of investors who wanted a balanced investment policy that catered to both current income and capital appreciation. In year zero, one-third of the earnings ($240,000 3 = $80,000) would be paid to the owners as a dividend, which gave each of them an income of $40,000. After payment, the company would be left with $160,000 to reinvest in the business. Earnings would continue to grow, and dividends would increase proportionately. Thus, dividends and earnings would grow by 8 per cent per annum (12 per cent earned on net worth less 4 per cent paid out from net worth). After 10 years, the company's net worth would be $4,317,850-the result of the original $2 million compounded at 8 per cent per annum. The dividend payment would be $86,357. The market value of each individual's holding would be $2,698,656. Scenario B: Sell Off This scenario reflected Buffet's philosophy and was followed by Berkshire Hathaway. Under this scenario, there would be no dividend payment and the entire earnings would be reinvested in the business. In order to maintain an income without dividends, each owner would sell 3.2 per cent of their respective holding. Based on the prospective buyer's offer, the sale would earn 125 per cent of the shares' book value. So, in year zero, each owner would be able to earn the same $40,000 from the sale of shares ($2.5 million 3.2 per cent 2). At the same time, the entire earnings of $240,000 would be reinvested in the company, which has a growth rate of 12 per cent per annum. After 10 years, the company's net worth would be $6,211,696the result of the original $2 million compounded at 12 per cent per annum. Because the owners had been selling shares each year, the percentage of each owner's share would have dropped. After 10 years, each owner would hold 36.12 per cent of the business, which would amount to a value of $2,243,665. The market value would be 125 per cent of the net worth, meaning the market value of the individual shares would amount to $2,804,425. Thus, the sell-off scenario, while providing the owners with their required income, added more value to the capital approximately $105,770 more than with the dividend scenario. 34 Buffet's other argument against paying dividends considered the needs of individual shareholders. When a company paid a dividend, it decided the amount that each shareholder would receive. Thus, dividend payments permitted the company to decide the shareholder's income. For example, if a company decided to pay out 40 per cent of the earnings, any shareholder who wanted income amounting to 50 per cent or 60 per cent would be dismayed. The sell-off option, however, allowed shareholders to sell their shares in accordance with their income requirement." 35 To reassert the philosophy of sell off as a substitute for dividend, Buffett revealed that from 2005 until 2012, he had annually divested 4.25 per cent of his shares. Thus, his original holdings of 712,497,000 B- equivalent shares were decreased to 528,525,623 shares a loss of almost 26 per cent. However, even though the percentage of Buffet's ownership had decreased, the book value of his holdings had increased significantly from $28.2 billion for 2005 to $40.2 billion for 2012-a gain of over 140 per cent.3 36 EXHIBIT 2: BERKSHIRE HATHAWAY BALANCE SHEET, 2013-2017 (IN US$ MILLIONS) 2013 2014 2015 2016 2017 Assets Cash & Short-Term Investments 48,186 63,269 71,730 86,370 115,954 Total Accounts Receivable 33,323 34,418 36,075 40,397 42,326 Inventories 9,945 10,236 11,916 15,727 16,187 Total Current Assets 91,454 107,923 119,721 142,494 174,467 Property, Plant & Equipment Gross 159,261 179,426 190,972 202,991 214,248 Accumulated Depreciation 37,047 42,182 45,806 50,218 56,029 Net Property, Plant & Equipment 122,214 137,244 145,166 152,773 158,219 Total Investments and Advances 177,858 180,150 182,990 178,098 204,975 Intangible Assets 66,194 70,655 72,505 113,572 114,440 Other Assets 27,211 30,214 31,875 33,917 49,994 Total Assets 484,931 526,186 552,257 620,854 702,095 Liabilities & Shareholders' Equity Short-Term Debt & Current Portion 6,634 Long-Term Debt 8,283 1,989 12,350 19,893 Accounts Payable 37,835 40,223 31,271 35,042 35,903 Total Current Liabilities 44,469 48,506 33,260 47,392 55,796 Long-Term Debt 65,590 71,926 82,300 89,294 82,694 Deferred Taxes 57,739 61,235 63,126 77,944 56,607 Other Liabilities 92,648 101,492 114,944 119,865 155,044 Total Liabilities 260,446 283,159 293,630 334,495 350,141 Shareholders' Capital 35,480 35,581 35,628 35,689 35,702 Retained Earnings 186,410 204,589 219,922 247,312 312,594 Accumulated Minority Interest 2,595 2,857 3,077 3,358 3,658 Total Equity 224,485 243,027 258,627 286,359 351,954 Liabilities & Shareholders' Equity 484,931 526,186 552,257 620,854 702,095 Note: Fiscal year is January to December. Source: "Berkshire Hathaway Inc.: Balance Sheet," Wall Street Journal, accessed June 15, 2018, https://quotes.wsj.com/BRKB/financials/annual/balance-sheet. EXHIBIT 3: BERKSHIRE HATHAWAY STATEMENT OF PROFIT AND LOSS, 2013-2017 (IN US$, MILLIONS EXCEPT EARNINGS PER SHARE) 2013 2014 2015 2016 2017 Sales/Revenue 179,770 194,864 209,995 222,935 241,419 Cost of Goods Sold (COGS) 138,636 149,594 157,051 169,146 197,662 including Depreciation & Appreciation Gross Income 41,134 45,270 52,944 53,789 43,757 Selling, General & Administrative (SGA) Expenses 11,917 13,721 15,309 18,217 18,181 Earnings Before Interest & Taxes 29,217 31,549 37635 35572 25,576 Unusual Expense -2,380 191 -948 -669 -718 Equity in Affiliates (Pre-Tax) - - -122 923 2,938 Interest Expense 2,801 3,253 3,515 3,497 5,394 Pre-Tax Income 28,796 28,105 34,946 33,667 23,838 Income Tax 8,951 7,935 10,532 9,240 -21,515 Consolidated Net Income 19,845 20,170 24,414 24,427 45,353 Minority Interest Expense 369 298 331 353 413 Net Income 19,476 19,872 24,083 24,074 44,940 Net Income After Extra-ordinaries 19,476 19,872 24,083 24,074 44,940 Net Income Available to Common 19,476 19,872 24,083 24,074 Shareholders 44,940 Earnings per Share (Basic) 7.9 8.06 9.77 9.76 18.22 Earnings per Share (Diluted) 7.9 8.06 9.77 9.76 18.22 Note: Fiscal year is January to December.