Case Study - Cooper Industries

Dividend Policy at FPL Group, Inc. (A) & (B)

1. A) Why do firms pay dividends?

Firms pay dividends depending on their financing and investment decisions. If they plan on financing through borrowing, then that releases cash for dividends in order to eliminate having large cash balances on hand. In addition, dividends are an immediate cash payment to the stockholder that they can spend or reinvest.

B) What, in general, are the advantages of paying dividends?

Dividend payments can be considered advantageous as signaling devices in the market. If dividends increase, it is interpreted that the company's value has increased and the stock goes up. If the earnings decrease and the company continues to pay the regular dividends, this makes the statement that the company is sound and the decrease is temporary and in the long run the money will be there. If the company pays out too much, then they can replace the cash by issuing new stock at no cost without signaling consequences.

C) What are the disadvantages of paying dividends?

Dividend payments can be a disadvantage in the market as a signaling device. If dividends decrease, it is interpreted that the company's value has decreased. This can cause the investors to sell the stock and send the price down in the market.

Another disadvantage is that paying dividends may result in selling new stock if the earnings retained are reduced or exhausted. This can lead to fewer earnings for the stockholder. Furthermore, dividends are taxed as ordinary income.

2. A) What are the most important issues confronting the FPL Groups in May 1994?

The most important issues confronting FPL Groups are:

* The effect that retail wheeling will have on FPL if it is authorized by the

Florida Public Service Commission is that it could bring about fierce

competition from large investor-owned utilities in neighboring states.

Florida's 4 major investor-owned utilities are providing 73% of the state's

generating capacity, 20 municipal and rural cooperative generating systems

are generating 24% capacity, and 19 independent power producers, which

includes qualifying facilities, are generating 3% capacity. This competition

could decrease their market value.

* Even though its financial performance is improving, there is concern about

interest expense as there has been a 140 basis point increase in long-term

interest rates since September 1993. From September 1993 to May 1994,

FPL's stock price fell by 19.6% and the S&P's Electric Utilities Index had

fallen by 22.1%.

B) What are the issues in setting dividend policy?

When managers set dividend policy they decide the policy that best meets their

companies needs. According to William R. Lasher in Practical Financial

Management (p 550), the three common policies are:

* Target payout ratio - the firm selects a long-run payout ratio that's comfortable. The payout ratio stays below the target in order to allow for variations in earnings that does not force a decrease in dividends.

* Stable dividend per share - The dividend remains constant regardless of earnings unless there is evidence of financial trouble and payment of dividends is in doubt. As long as things are going well with the company and its growth, then dividends can be raised.

* Small regular dividend with a year-end extra if earnings permit - This policy assures stockholders of a regular dividend, and can either pay or forgo the year-end extra.

FPL has been using the stable dividend per share policy in such that it has paid dividends regularly, and consistently increased the dividends to a high payout ratio in the industry. As the company makes changes to their policy, their goal is to align their financial strategy with their competitive strategy which means a decrease in dividends. Per the Dividend Policy at FPL Group, Inc. (B), the issues surrounding this change in policy are:

* Reduction of the dividend by 32% ($248 to $1.68) will increase the cash flow

by approximately $145 million per year; and establish a new target dividend

payout ratio of 60% to 65% of prior year's earnings.

* Begin a repurchase program: FPL will buy ten million common shares over the next three years and at least four million shares in the next twelve months.

* Move the dividend review from the annual meeting in May to February in order to link the dividend and annual earnings announcements more closely

3. A) From FPL's perspective, is the current payout ratio appropriate?

FPL has decided that its dividend payout is inappropriately high with the ratio at

91% in 1993. Due to the increasing risks in the industry, such as deregulation,

there is a cause for uncertainty.

Investor-Owned Utilities in the Southeast U.S. in 1993 (from Exhibit 7)

Utilities Payout Ratio Dividend Yield

FPL Group 91% 6%

Carolina Power 74% 5%

Duke Power 68% 5%

Florida Progress 87% 6%

SCANA Corp. 74% 6%

The Southern Co. 75% 5%

TECO Energy, Inc. 73% 4%

B) Would a higher payout be more appropriate (substantiate your position)?

No, FPL is already at