Dividend Policy at Fpl - Why Do Firms Pay Dividends?

Executive Summary

The report has been created to provide a valuation of Florida Power and Light Company's financial status and determine an appropriate course of action for FPL in regards to its dividend policy.

WE used payout ratios and analyzed the company's cash flow to maintain our recommendation. This was made harder by the variance of market forces.

Our final recommendation for FPL is to cut its dividend of $2.47 by 30%. This allows room for future dividend growth rate of 4% over the next few years, as well as maintaining a safe level of cash reserves to cover any potential maturing debt.

Discussion

Why do firms pay dividends

A standard firm's main objective is to maximize the value of the firm. This can be achieved through a number of ways however if the firm does not have the opportunity to invest in projects that yield a return greater than the minimum acceptable hurdle rate the firm should return earning to stockholders. This can be done through paying a special or regular cash dividend which is a way of transferring excess firm cash from earnings to the firm's stockholders.

Paying out dividends can tell the market that the company is earning more then what is available to invest in, that is the firm has surplus earning then what is required to cover operational costs. The market may take this as a good signal about the future stability of the firm's earnings especially if the firm pays out dividends on regular bases as there is a positive correlation between earnings and the dividend payout level, that is the dividend payout level follows earnings movement overtime.

However depending on what stage the firm is in of its life cycle the market may view a (increasing) dividend as a result of the lack of potential investment and growth opportunities which it can undertake. For example young firms are less likely to pay dividends as they tend to have large investment opportunities and require the earnings for growth and to cover larger marginal costs. Therefore shareholders of younger or intermediate firms are likely to see a dividend payout as negative sign as they would prefer that the excess earning be reinvested and for the firm to grow.

Compare this to older more established firms which will have less investment opportunities and higher and more stable earnings to cover marginal costs will tend to pay out dividends more often. Shareholders of well established large firms come to expect regular dividends and see a dividend increase as a positive sign.

This shows that dividend payouts can have both advantages and disadvantages depending on how the market and stockholders views them and the signal it sends out about future cash flows.

One advantage of increasing the dividend if a company already has a track record