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Dividend policy at linear technologies case solution

The first issue is whether dividend is needed or not and the second issue is regarding which one would be the best option among various payout methods. Lastly, the third issue is about dividend rate. Whether these issues will affect corporate values has been debated over the years. This paper will talk about such issues through the case study of Linear Technology.

Why dividend is needed. Linear has provided steady dividends since 1992 in a gradually increasing rate in small amounts. Why do firms pay dividends?

Can dividends raise the value of firms? For the detailed reference and information, the appendix attached at the end can be reviewed. There would be two different kinds of approaches to this example.

We can simulate two symmetric firms that only vary in the dividend payout ratio. If there is a difference in firm values or share prices between these firms, investors would not let it be and just do their households.

Investors in the market would reveal the opportunity of arbitrage. Therefore, the value of two symmetric firms should be the exactly the same. To sum up, there would be no change in value, earnings or EPS. The stock price would just decline just as the amount of dividend payout.

However, if we peel the onion of assumptions, things get different. On the other hand, by taking the second approach and sticking to the fact that dividend policies can affect the value of the firm, we can compare new result with the prior result. Being a growth stock means the company earns more than what its shareholders request for their investment. But Linear has paid out constant dividends in spite of the results above. The reasons are as follows. Linear believes that offering dividends appeals to potential investors who not only focus on the growth of the firm but also have interests in definite incomes.

Some shareholders may prefer dividends now rather than uncertain income of the future. They also thought that providing dividends can give a signal which represents stability of business as supported by 1 See M.

Dividend Policy, growth and the Valuation of Shares dividend signaling hypothesis. It can also make it easier to get more money by getting into debts. And dividend policy at linear technologies case solution numerous studies assert the fact that firms with more favorable inside information optimally pay higher dividends and receive appropriately higher prices for their stock 2.

Linear is powering through stock repurchase in the recent fiscal years. There are two major reasons explaining this increasing amount of stock repurchase. In order to counterbalance the exercise of stock options, Linear is buying back stock. Another reason is the lack of profitable investment opportunities. But the practical reasons exist. Stock repurchases are discretionary compared to dividends.

Go back to the example mentioned above. If the company pays out by repurchasing shares, the two approaches do not show a difference. Accordingly, the market price would result in decreased future earnings, EPS, and the firm value of Linear. The number of outstanding shares, instead of the price, will decrease. While the price of stock would increase just as the amount of cash paid out to repurchase the outstanding stocks.

It is important that in both cases, earnings and earnings per share before the payment are not affected. About the dividend rate Firms judge the rate of dividend initiations by earnings. However, simply put, if dividend rate changes depending on the change of earnings, the fluctuation of dividend will increase. This would not be good. Because cutting dividends means uncertain future cash flows. If a company cuts dividend rate, shareholders will need higher opportunity costs of capital, as a result stock prices will go down.

Dividend policy at Linear Technology

Thus, Linear has retained constantly increasing dividend rates in small amounts. However, considering the real-life factors, firms should keep on steady level of dividend rate or repurchasing shares. Repurchasing shares seems to be a better solution. Dividends, Dilution, and Taxes: Dann, Common stock repurchases: Two symmetric firms that only vary in dividend payout ratio.

Linear Technology 2003 Annual Report http: