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- Critically evaluate Chucks suggestion of following a residual dividend policy accompanied by a repurchase of stock at $8 per share. What are the pros and cons of using a stock repurchase option instead of a cash dividend to distribute returns to shareholders?
Is It Much Ado About Nothing? It was the end of the fourth quarter. The financial statements had been prepared and circulated to the directors of NuSkin Products Inc. (Tables 2 and 3). The firm's revenues had surpassed the previous quarters revenues by over 20%, and the annual sales were approximately 15% higher as well. More importantly, the net income figures for the year were up by more than 25%. The restructuring and cost cutting seemed to have paid off. Needless to say, the mood at the corporate headquarters in Fort Myers, Florida, was upbeat and full of good cheer. This year's performance ended a long streak of down years and mounting losses. The big question weighing heavily on everyone's minds was, When will they ever pay a dividend? That exactly was to be the main topic of discussion at that day's meeting of the board of directors. Chuck Symanski, a retired biochemist, founded NuSkin Products Inc., approximately 12 years ago in his hometown of Grand Rapids, Michigan. With $500,000 of his own money and the rest borrowed from a local banker, Chuck started manufacturing various patented lotions, hair color dyes, and facial creams in his small facility. Initially, business was slow: It took the company almost three years before it made its first profit. Soon thereafter, having struck major deals with overseas clients, NuSkin began to do well. Sales started to climb and the company shifted its headquarters to Fort Myers, FL, after issuing 1,000,000 shares in an initial public offer- ing. Although the company made good profits during the next four years, the board of directors had decided to retain all of the earnings and reinvest them into the business. They did so for a couple of years and then owing to a downturn in the economy and excessive expenses, the company ended a number of years in the red. Luckily, the company had not accumulated ex- cessive amounts of debt and was able to withstand the difficult times quite well. During this down period the stock price went from a high of $25 to a low of $2. It was currently trading at $8 per share with a P/E ratio of 8.33. As the directors gathered for the meeting, Chuck, the president and chief executive officer, knew that this was going to be an interesting meet- ing given the significantly different backgrounds, personalities, and beliefs of the directors. No sooner had he completed his introductory remarks and raised the question regarding the dividend policy issue than Bernie Simmons raised his hand, Why fix it if it ain't broke? he asked in his usual flippant style. I think we should continue retaining all our earnings and use the money for future investments. I think it would be financially imprudent for us to pay dividends when we know that we are going to have to raise $1,000,000 for that expansion project we had approved last month. Why pay the flotation costs? Besides, don't stock prices almost always drop after dividend payments? Chuck knew that he had opened a can of worms. He could feel the room begin to erupt. Sure enough, up went Geoff Scott's long arm. I think we owe it to our shareholders. They have waited a long time for a dividend and might vote with their feet if we don't pay any dividends. I think we should identify our existing shareholder groups and make a decision based on what the majority prefers (see Table 1 for shareholding information). Helen Bedford, who had a degree in finance from one of the top schools in the country, and had read about Modigliani and Miller's (M&Ms) dividend ir- relevancy proposition, couldn't hold back any longer. Gentlemen, she said. Isn't this much ado about nothing? I think we are wasting our time arguing about whether or not dividends should be paid and if so, how much. I think it really doesn't matter one way or the other as far as stock prices are concerned. Those shareholders who don't like our dividend policy can create homemade dividends for all I care. I think we need to move on to more important issues, like where we are going to have our next annual general meeting. Surprising- ly, nobody smiled. I'm just kidding, she said. I think we should use the residual dividend approach, said Bob Pritchett. That way we can keep our shareholders happy and maintain our target capital structure. I tend to agree with Geoff. The shareholders are expecting some kind of dividend, and if we don't deliver we could hurt the stock price. But we have to be able to support whatever dividend payout ratio we go with, or else the negative information backlash could come back to haunt us. Table 3 NuSkin Products Inc. Balance Sheet Cash Accounts Receivable Inventory Total Current Assets $250,000 $450,000 $675,000 $1,375,000 Accounts Payable Accruals Deferred Taxes Total Current Liabilities Long-Term Debt $300,000 $250,000 $100,000 $650,000 $3,350,000 $4,000,000 Net Fixed Assets $8,000,000 Total Liabilities Common Stock: Intangibles $625,000 Par Value Paid In Capital Retained Earnings Shareholders' Equity Total Liabilities & Shareholders' Equity $2,000,000 $3,000,000 $1,000,000 $6,000,000 Total Assets $10,000,000 $10,000,000 Is It Much Ado About Nothing? It was the end of the fourth quarter. The financial statements had been prepared and circulated to the directors of NuSkin Products Inc. (Tables 2 and 3). The firm's revenues had surpassed the previous quarters revenues by over 20%, and the annual sales were approximately 15% higher as well. More importantly, the net income figures for the year were up by more than 25%. The restructuring and cost cutting seemed to have paid off. Needless to say, the mood at the corporate headquarters in Fort Myers, Florida, was upbeat and full of good cheer. This year's performance ended a long streak of down years and mounting losses. The big question weighing heavily on everyone's minds was, When will they ever pay a dividend? That exactly was to be the main topic of discussion at that day's meeting of the board of directors. Chuck Symanski, a retired biochemist, founded NuSkin Products Inc., approximately 12 years ago in his hometown of Grand Rapids, Michigan. With $500,000 of his own money and the rest borrowed from a local banker, Chuck started manufacturing various patented lotions, hair color dyes, and facial creams in his small facility. Initially, business was slow: It took the company almost three years before it made its first profit. Soon thereafter, having struck major deals with overseas clients, NuSkin began to do well. Sales started to climb and the company shifted its headquarters to Fort Myers, FL, after issuing 1,000,000 shares in an initial public offer- ing. Although the company made good profits during the next four years, the board of directors had decided to retain all of the earnings and reinvest them into the business. They did so for a couple of years and then owing to a downturn in the economy and excessive expenses, the company ended a number of years in the red. Luckily, the company had not accumulated ex- cessive amounts of debt and was able to withstand the difficult times quite well. During this down period the stock price went from a high of $25 to a low of $2. It was currently trading at $8 per share with a P/E ratio of 8.33. As the directors gathered for the meeting, Chuck, the president and chief executive officer, knew that this was going to be an interesting meet- ing given the significantly different backgrounds, personalities, and beliefs of the directors. No sooner had he completed his introductory remarks and raised the question regarding the dividend policy issue than Bernie Simmons raised his hand, Why fix it if it ain't broke? he asked in his usual flippant style. I think we should continue retaining all our earnings and use the money for future investments. I think it would be financially imprudent for us to pay dividends when we know that we are going to have to raise $1,000,000 for that expansion project we had approved last month. Why pay the flotation costs? Besides, don't stock prices almost always drop after dividend payments? Chuck knew that he had opened a can of worms. He could feel the room begin to erupt. Sure enough, up went Geoff Scott's long arm. I think we owe it to our shareholders. They have waited a long time for a dividend and might vote with their feet if we don't pay any dividends. I think we should identify our existing shareholder groups and make a decision based on what the majority prefers (see Table 1 for shareholding information). Helen Bedford, who had a degree in finance from one of the top schools in the country, and had read about Modigliani and Miller's (M&Ms) dividend ir- relevancy proposition, couldn't hold back any longer. Gentlemen, she said. Isn't this much ado about nothing? I think we are wasting our time arguing about whether or not dividends should be paid and if so, how much. I think it really doesn't matter one way or the other as far as stock prices are concerned. Those shareholders who don't like our dividend policy can create homemade dividends for all I care. I think we need to move on to more important issues, like where we are going to have our next annual general meeting. Surprising- ly, nobody smiled. I'm just kidding, she said. I think we should use the residual dividend approach, said Bob Pritchett. That way we can keep our shareholders happy and maintain our target capital structure. I tend to agree with Geoff. The shareholders are expecting some kind of dividend, and if we don't deliver we could hurt the stock price. But we have to be able to support whatever dividend payout ratio we go with, or else the negative information backlash could come back to haunt us. Table 3 NuSkin Products Inc. Balance Sheet Cash Accounts Receivable Inventory Total Current Assets $250,000 $450,000 $675,000 $1,375,000 Accounts Payable Accruals Deferred Taxes Total Current Liabilities Long-Term Debt $300,000 $250,000 $100,000 $650,000 $3,350,000 $4,000,000 Net Fixed Assets $8,000,000 Total Liabilities Common Stock: Intangibles $625,000 Par Value Paid In Capital Retained Earnings Shareholders' Equity Total Liabilities & Shareholders' Equity $2,000,000 $3,000,000 $1,000,000 $6,000,000 Total Assets $10,000,000 $10,000,000
