Fpl Case Report

Introduction

FPL Group, whose main subsidiary is the Florida Power & Light Company (FP&L), the largest electric utility company in Florida, was formed in 1925. Through all these years, this subsidiary has been the major contributor to the company's total revenue, as till 1994, the percentage of total revenue made by FP&L was almost 97% within the corporation.

As we know, in the electric utility industry, it is common to see utility companies with high dividend payout, and levered with large amount of debt. In FPL's case, it also happened, and as this situation continues till recently the extremely high interest and the pressure to maintain a steadily growth dividend payout become a huge burden on company's financial condition. FPL is now struggling with its dividend policies, whether to cut or keep.

Relevant Theories to Case Study

M&M Propositions: According to M&M Propositions, the change in dividend policy of a company should have no effect on the company's share price, as if a firm's investment and debt policy are fixed. It is because a dividend is just a partial liquidation of the original shareholders' interest in the firm. Hence, the original shareholders who can, if they wish, use their dividend cash to restore their proportional claim on the firm by purchasing some of the issued shares. However, in real life, when the company is paying a dividend, the dividends expose all shareholders to ordinary income tax, and also a transaction cost may incur during the process, if the company have to issue new shares to cover the cost of paying dividends. This fact will greatly affect shareholders and management's decisions.

Taxes: Taxes play a very important role in affecting shareholder's dividend preferences. If a firm's equity investors do want/need regular cash income, then whether they prefer a dividend or to simply sell some shares depends on the relative sizes of taxes on dividends and taxes on realized capital gains. They will compare the possible loss brought by these two different rates, and in favor of the one which bring less loss. Different companies with different dividend policies combine with tax rates may bring different benefit to specific groups of people, then a set of investors who are attracted to the stocks of firms that have the dividend policy they prefer, based on their tax and/or liquidity circumstances will become the dividend clienteles of the company. This suggests that a given firm may be able to increase its market value if it adopts a dividend policy that appeals to investors whose preferences are not satisfied by firms currently in the market.

Agency Problems: Two principal-agent problems attend a firm's dividend policy. These are the free cash flow problem and the incentive of a levered firm to expropriate wealth