MINICASE George Liu, the CEO of Penn Schumann, was a creature of habit. paid out about 40% of earnings as dividends, though the figure in Every month, he and Jennifer Rodriguez, the company's chief 2019 was only 35%. Penn was spending more than $4 billion a year financial officer, met for lunch and an informal chat at Pierre's. on R&D, but the strong operating cash flow and conservative divi- Nothing was ever discussed until George had finished his favorite dend policy had resulted in a buildup of cash. Penn's recent income escalope de foie gras chaude. At their last meeting in March, he statements, balance sheets, and cash-flow statements are summa- had then toyed thoughtfully with his glass of Chateau Haut-Brion rized in Tables 17.3, 17.4, and 17.5. Blanc before suddenly asking, "What do you think we should be The problem, as Mr. Liu explained, was that Penn's dividend doing about our payout policy?" policy was more conservative than that of its main competitors. Penn Schumann was a large and successful pharmaceutical com- "Share prices depend on dividends," he said. "If we raise our divi- pany. It had an enviable list of highly profitable drugs, many of dend, we'll raise our share price, and that's the name of the game." which had 5 or more further years of patent protection. Earnings in Ms. Rodriguez suggested that the real issue was how much cash the the latest 4 years had increased rapidly, but it was difficult to see that company wanted to hold. The current cash holding was more than such rates of growth could continue. The company had traditionally adequate for the company's immediate needs. On the other hand,the research staff had been analyzing a number of new compounds earnings per share would increase to $9.84. If the price-earnings with promising applications in the treatment of liver diseases. If multiple stays at 1 1.8, the stock price should rise to $116. That's an this research were to lead to a marketable product, Penn would increase of over 10%." A smile came over Mr. Liu's face. "Wonder- need to make a large investment. In addition, the company might ful," he exclaimed, "here comes my homard a la nage. Let's come require cash for possible acquisitions in the biotech field. "What back to this idea over dessert." worries me," Ms. Rodriguez said, "is that investors don't give us Evaluate the arguments of Jennifer Rodriguez and George Liu. credit for this and think that we are going to fritter away the cash on Do you think the company is holding too much cash? If you do, negative-NPV investments or easy living. I don't think we should how do you think it could be best paid out? commit to paying out high dividends, but perhaps we could use some of our cash to repurchase stock." "I don't know where anyone gets the idea that we fritter away TABLE 17.4 Penn Schumann Inc. income statement cash on easy living," replied Mr. Liu, as he took another sip of (figures in millions wine, "but I like the idea of buying back our stock. We can tell shareholders that we are so confident about the future that we 2019 2018 believe buying our own stock is the best investment we can make." Revenue $16,378 $13,378 He scribbled briefly on his napkin. "Suppose we bought back 50 Costs 8,402 7,800 million shares at $105. That would reduce the shares outstanding to Depreciation 928 850 488 million. Net income last year was nearly $4.8 billion, so EBIT $ 7,048 $ 4,728 Interest 323 353 TABLE 17.3 Penn Schumann Inc. balance sheet Tax 1,933 1, 160 (figures in millions of dollars) Net income $ 4,792 $ 3,215 2019 2018 Dividends $ 1,678 $ 1,350 6.23 $ 7,061 $ 5,551 Earnings per share ($) 8.9 Cash and short-term investments 3.12 2.62 Receivables 2,590 2,214 Dividends per share ($) Inventory 1,942 2,435 Total current assets $1 1,593 $ 10,200 TABLE 17.5 Penn Schumann Inc. statement of cash flows $21,088 $ 19,025 (figures in millions) Property, plant, and equipment Less accumulated depreciation 5,780 4,852 2019 Net fixed assets $ 15,308 $14, 173 Net income $ 4,792 Total assets $26,901 $24,373 Depreciation 928 Payables $ 6,827 $ 6,215 Decrease (increase) in receivables (376) Short-term debt 1,557 2,620 Decrease (increase) in inventories 493 Total current liabilities $ 8,384 $ 8,835 Increase (decrease) in payables 612 Long-term debt 3,349 3,484 Total cash from operations $ 6,449 Shareholders' equity 15, 168 12,054 Capital expenditures (2,063) Total liabilities and equity $26,901 $24,373 Increase (decrease) in short-term debt (1,063) Note: Increase (decrease) in long-term debt (135) Shares outstanding (millions) 538 516 Dividends paid (1,678) Market price per share ($) 105 88 Cash provided by financing activities $ (2, 876 ) Net increase in cash $ 1,510