Cash Distributions

•A company must have cash before it can make a cash distribution to shareholders, we will examine a company’s sources of cash.
•Occasionally the cash comes from a recapitalization or the sale of an asset, but in most cases it comes from the company’s internally generated free cash flow.
•Recall that FCF is defined as the amount of cash flow available for distribution to investors after expenses, taxes, and the necessary investments in operating capital. Thus, the source of FCF depends on a company’s investment opportunities and its effectiveness in turning those opportunities into realities.
•Notice that a company with many opportunities will have large investments in operating capital and might have negative FCF even if it is profitable. When growth begins to slow, a profitable company’s FCF will be positive and very large. Home Depot and Microsoft are good examples of once-fast-growing companies that are now generating large amounts of free cash flows.

•There are only five potentially “good” ways to use free cash flow:
(1) pay interest expenses (after tax)
(2) pay down the principal on debt
(3) pay dividends
(4) repurchase stock
(5) buy short-term investments or other non-operating assets.
•If a company’s FCF is negative, then its “uses” of FCF must also be negative. For example, a growing company often issues new debt rather than repaying debt and issues new shares of stock rather than repurchasing outstanding shares. Even after FCF becomes positive, some of its “uses” can be negative.

•A company’s capital structure choice determines its payments for interest expenses and debt principal. A company’s value typically increases over time, even if the company is mature, which implies its debt will also increase over time if the company maintains a target capital structure.
•If a company instead were to pay off its debt, then it would lose valuable tax shields associated with the deductibility of interest expenses. Therefore, most companies make net additions to debt over time rather than net repayments, even if FCF is positive. The addition of debt is a “negative use” of FCF, which provides even more FCF for other uses.

•A company’s working capital policies determine its level of short-term investments, such as T-bills or other marketable securities. Recognize that the decision involves a trade-off between the benefits and costs of holding a large amount of short-term investments.
•In terms of benefits, a large holding reduces the risk of financial distress should there be an economic downturn. Also, if growth opportunities turn out to be better than expected, short-term investments provide a ready source of funding that does not incur the flotation or signaling costs due to raising external funds.
•However, there is a potential agency cost: If a company has a large investment in marketable securities, then managers might be tempted to squander the money on perks (such as corporate jets) or high-priced acquisitions.

•However, many companies have much bigger short-term investments than the previous reasons can explain. For example, Apple has over $100 billion and Microsoft has about $60 billion. The most rational explanation is that such companies are using short-term investments temporarily until deciding how to use the cash.
•Purchasing short-term investments is a positive use of FCF, and selling short-term investments is negative use. If a particular use of FCF is negative, then some other use must be larger than it otherwise would have been.

•In summary, a company’s investment opportunities and operating plans determine its level of FCF. The company’s capital structure policy determines the amount of debt and interest payments. Working capital policy determines the investment in marketable securities. The remaining FCF should be distributed to shareholders, with the only question being how much to distribute in the form of dividends versus stock repurchases.
•Obviously this is a simplification, because companies (1) sometimes scale back their operating plans for sales and asset growth if such reductions are needed to maintain an existing dividend, (2) temporarily adjust their current financing mix in response to market conditions, and (3) often use marketable securities as shock absorbers for fluctuations in short-term cash flows. Still, there is an interdependence among operating plans (which have the biggest impact on free cash flow), financing plans (which have the biggest impact on the cost of capital), working capital policies (which determine the target level of marketable securities), and shareholder distributions.






Последнее изменение: вторник, 14 августа 2018, 08:54