Integrated Waveguide Technologies (IWT) is a 6-year-old company founded by Hunt Jackson and David Smithfield to develop and manufacture miniature microwave-frequency directional transmitters and receivers for mobile Internet and communications applications using metamaterial plasmonics technology . IWT's technology, while advanced, is relatively cheap to implement, and its proprietary manufacturing techniques require little capital compared to many electronics manufacturing companies. With low capital requirements, Jackson and Smithfield were able to avoid issuing new shares and thus own all of the shares. With soaring demand for its mobile internet app, IWT must now secure outside equity capital to fund its growth, and Jackson and Smithfield have decided to take the company public. So far, Jackson and Smithfield have paid themselves a reasonable salary, but often reinvest all after-tax earnings in the company, so the dividend policy has not been an issue. However, before talking to potential outside investors, they must decide on a dividend policy. Your new boss at the consulting firm Flick and Associates, hired to help IWT prepare for its public offering, asks you to give a presentation to Jackson and Smithfield reviewing the theory of dividend policy and discussing the following issues.

a. (1) What does the term "allocation policy" mean? How has the mix of dividends and share repurchases changed over time?

b. Discuss the impact of an allocation policy that is subject to: (1) the signaling assumption (also known as the information content assumption) and (2) the client effect.

c. (1) Assumes IWT has completed its IPO and has a capital budget of $112.5 million planned for the coming year. You have determined that its current capital structure (80% equity and 20% debt) is optimal and that its net income is expected to be $140 million. Use the residual allocation method to determine the total dollar allocation for IWT. Now suppose the distribution is in the form of a dividend. Assume that IWT has 100 million shares outstanding. What is the expected payout ratio? What is the estimated dividend per share? What happens to payout ratio and DPS if projected net income falls to $90M? Increase to $160 million?

(3) What are the advantages and disadvantages of the residual policy? (Tip: Don't ignore signal and client effects.)

e. Discuss the pros and cons of a company repurchasing its own stock.