International Finance Strategy - Dominos Pizza - Essay Example

International Finance Strategy Question Part A Literature Review of Dividend Policy Within the scope of corporate finance, finance managers have todeal with two major decisions related to operations, namely capital budgeting decisions and financing decisions. Capital budgeting decisions refers to choices made over firm assets and financing decisions deal with choices regarding manner in which these assets shall be funded so as to create profits. Once the firms generate profits, another aspect is added to financial decisions making pertaining to distribution of profits earned. The call is to be made between distribution of profits as dividend to shareholders or keeping it in business for investment decisions. Dividend policy pertains to the practice of company’s management in providing dividend payments or taking decisions related to the pattern and size of dividend cash distributions, which are to be made by the company to its shareholders (Nissam and Ziv, 2001). This decision to distribute company profits is critical for the company as it influences the capital structure as well as the stock prices. There are three basic contradictory theories in relation to dividend policies of firms. The first view in this regard claims that increase in dividend payments help to improve firm value. This is the bird in hand argument. The second view postulates that high payouts in the form of dividends have a conflicting effect on value of firm and is known as the tax preference argument. The third view is the dividend irrelevance hypothesis, which asserts that dividend decisions are irrelevant and dividend policy decision has no significant effect on the firm. Corporate managers have been able to realize that dividend payments are necessary to satisfy expectations of the company shareholders. They have tried to smooth out dividends over a long period of time because it is believed that reducing dividends might uphold an unfavourable image of the company to its shareholders. Hence, dividends are also used to give signals to the market about company performance and stability. Dividend policies have a huge impact on a company’s stock prices. There has been an ongoing debate regarding the impact of a firm’s dividend policy over its value and capital structure decisions since 1950s. The following sections shall discuss the issue in detail. Literature Review of Capital Structure In financial terms, the capital structure is a framework based on which a company finances the assets in combination of equity, debt and hybrid form of securities. The capital structure of a company is simply the formation of a company’s liabilities. According to the theorem proposed by Modigliani and Miller, value of a company in a perfect market is not relevant to the manner in which a company is financed. This theory also advocated that value of any firm is independent of the capital structure and that the cost of equity of a firm that is not leveraged is equivalent to that of a leveraged firm to which a risk premium needs to be added. As a result, one can derive that if the capital structure becomes relevant, then this shall be a cause of market imperfections. The Pecking order theory of capital structure tries to capture the costs pertaining to asymmetric information. The notion put forward by the Pecking order theory states that companies prioritize their finance sources from internal funds and end it with raising equity from the markets, thereby implying that when all options for internal and external debt are exhausted, the company opts for the issue of equity capital. Consequently, debt funds are preferred over equity funding by businesses in general (Fama and French, 2001). Relationship between Capital Structure and Dividend Policy For most theories, the dividend policy theories bear differences with those pertaining to capital structure of firms. However, there are adequate reasons to believe that there exists a relationship between the two. According to Faulkender, Milbourn and Thakur (2006), the determination of dividend policy and capital structure of firms is a joint decision, which contributes towards monitoring control allocations between investors and company managers. This control allocation is critical because of divergent beliefs held by the two sections, which result in healthy arguments between the two parties over value of any project available to the company. Then again, dividend is paid when the company has excess cash and in the presence of excess cash that is to be reinvested in business, companies consider their capital structure. Part B The company chosen for the purpose of this study is Dominos Pizza Inc, which is listed in the FTSE 250 Index. The pizza production and exploration company is based independently in the US and the UK. It also operates in numerous other countries across the globe. The 10 year financial record of the company was checked and their dividend payment policy has been presented below along with the changes in its capital structure. Fiscal Period 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Dividends Paid 21 27 30 897 -- -- -- -- 185 34 Long-Term Debt 755 702 740 1,705 1,725 1,522 1,451 1,450 1,536 1,512 Retained Earnings 859 778 702 1,445 1,422 1,342 1,254 1,208 1,335 1,289 Additional Paid-In Capital 302 260 134 -- 2 24 46 -- 2 1 (Source: Gurufocus, 2014) The above table shows that the company has been giving out dividends quite irregularly, which imply that the dividend payout is not well-structured for Dominos Pizza Inc. The dividends reflect that the firm has tried to retain the shareholders trust by paying out funds out of company’s own finances, but has been irregular in doing so. Additionally, retained earnings position of the firm is also not very impressive. Such a state indicates that Dominos is funding capital requirements out of its own funds, which have faced a downturn in the recent times. On further analysis, it was found that the company has maintained rising equity position for long in the past 10 years and has been managing its operations with a combination of long-term debts and equity finances. Invitation for additional capital was high in the initial years; but in the recent times, the company has sourced more of debt capital and funded out of retained earnings rather than inviting additional paid up capital funds. The capital structure of the firm has been maintaining a debt equity ratio close to the ideal at 1:1, thereby indicating that the fund management policy of Dominos Pizza is sound. The irregular nature of company’s dividend policy is on account of the company’s policy to pay dividend when they earn profits. In case of low profits or in the event of company’s investment plans, it does not pay dividends to the shareholders. Research suggests that fall in dividend payouts leads to weakening of shareholder interests and sentiments towards the company’s policies and plans. However, if the company clearly justifies and establishes good record of fund usage that entails better revenues in future, the shareholders might have faith in company management and not react adversely to share prices in the event of no dividend being paid. This is a long drawn and time taking process. Therefore, in the regular course of action, it is advised that companies pay small and regular dividends to its shareholders so as to retain their confidence as well as ensure that potential investors hold investment interests in the company so that funds are easily available when required. It is advised to Dominos that they change their dividend policy in order to facilitate payment of small and regular dividends, rather than having irregular patterns and percentages of dividend payouts. This will establish a stable image of the company. Question 2 Benefits of Mergers and Acquisitions Corporate growth and sustenance encompasses mergers and acquisitions as among the most prominent processes. This is the key component that has contributed towards restructuring of businesses in an innovative form and offers massive advantages to the business world. The first advantage associated with mergers is that firms are providing with a wider network for conducting business operations with a merger or an acquisition. For example, merger of T-mobile with Orange in UK created a super network nationally ensuring better services to consumers. The second benefit comes from the fact that an M&A activity facilitate higher funds for research and greater scope for development. The third advantage associated with M&A is that horizontal mergers assure scale economies that come with expansion of the range of production facilities. The fourth advantage of mergers and acquisitions is that of competition through consolidation of the firms. This also reduces duplication and duplication of production activities. The disadvantages associated with M&A are related to monopoly creation of firms through consolidation activities. Mergers lead to lesser competition and also assure higher market share to the companies which acquire. This gives them the monopoly power to charge higher prices for the products they sell. Another disadvantage associated with mergers and acquisition for the companies is that they have dilution of decision making roles at the board level through the inclusion of members through the newly added entity (Graham and Harvey, 2001). Mergers and acquisitions also have societal drawbacks associated with the loss of jobs as a process of consolidation and also give lesser choices to the consumer. Mergers and acquisitions might also lead to scale diseconomies in certain cases where a sudden increased size of a small firm might face some retaliation or lack of control over worker’s motivation and resources shortages. The key stakeholders of any company include its customers, shareholders, employees and government. The benefits of customers towards the merger and acquisition activity are that they shall have lower prices to pay for the same goods. This is expected because mergers lead to economies f scale and this leads to fall in costs of products. It is expected that the benefit of lower costs would be passed on to the ultimate consumer as a part of mitigating competition through price wars. For employees, mergers and acquisitions are expected to entail better opportunities for growth and development on the professional front. This is expected because as the company grows, it has larger areas to be managed and the company is expected to give preference to its existing employees to take up higher roles in management rather than relying on new recruits. For the shareholders, the acquisition process or a merger entails in expectation of higher profits in future as the company grows in size. It is expected that larger company shall be able to expand its operations and drive out competition to increase sales which in turn would raise company profits and hence benefit the shareholders of the company. For the government, a merger or an acquisition deal would lead to creation of monopoly power which would require higher government intervention and supervision. Larger companies can work in combination with the government and help towards attainment of goals at the national level. Funding Options The possible option for financing a takeover for any company is by way of raising additional debt capital to pay off for the expenses incurred in the merger and acquisition process. This is not a viable option for Dominos Pizza Inc because they already have high debt capital and raising additional debt might simply raise the debt equity ratio and this shall be highly undesirable on the part of the shareholders. The present Debt Equity ratio is hovering around the ideal of 1:1 which means that the company has enough equity finances to fund its debt obligations in the event of company liquidation. However, debt capital does The second option available for financing the M&A deal to the company is by way of using equity funds and raising additional capital for the purpose of acquiring or merging with the new firm. Raising equity capital is a long drawn expensive process of funding and it is difficult to invite funds for the merger or acquisition deal because the shareholders and potential investors have little confidence in the new deal and would not like to take risk in the company’s dealings. However, in case of large fund requirements, equity funding does become a good source of raising finance (Baker and Wurgler, 2004). The third option available is by way of using the retained earnings of the firm. These funds prove to be the best source of finance for merger and acquisition deals. The firm can use the available fund with minimum risk and least repayment obligations. The retained earnings however are small and require compromises on dividend payout of the company for which the company needs to seek approval of its shareholders at large. On the flip side, retained earnings do not invite any additional debt obligations and also do not bear interest payment burdens unlike debt funds. They however bear shareholder’s funds and interests. This is possibly the cheapest and the best source of finance for funding deals in relation to mergers and acquisitions. Hence, the options available to Dominos Pizza Inc specifically after having at the look at company finances is retained earnings and equity finance. Debt funds would add additional leverage for the company and this is not desirable. Reference List Baker, M., and Wurgler, J., 2004. A Catering Theory of Dividends. Journal of Finance, 59, pp. 1125-1165 Fama, E., and French, K. 2001. Disappearing Dividends: Changing Company Characteristics or Lower Propensity to Pay? Journal of Financial Economics, 60, pp. 3-43. Faulkender, M., Milbourn, T. and Thakor J., 2006. Capital structure and Dividend Policy: Two sides of a puzzle? Available at: http://etheses.bham.ac.uk/51/1/Manos01PhD.pdf> [Accessed 10 July 2014]. Graham, J. and Harvey, C., 2001. The Theory and Practice of Corporate Finance: Evidence from the Field. Journal of Financial Economics, 60, pp. 187-243. Gurufocus, 2014. Dominos Pizza Inc. Available at: [Accessed 10 July 2014]. Nissam, D., and Ziv, A., 2001. Dividend Changes and Future Profitability. Journal of Finance 56, pp. 2111-2133. Read More