Question

You are consulting with the board of directors for a small corporation called FunTime, Inc. FunTime, Inc. sells party and entertaining items. The board is looking at ways to make the stock more attractive to investors. FunTime wants to grow and expand the company.

There are a few main ways a company can affect the value of its stock. FunTime, Inc. board of directors could declare a cash dividend. Cash dividends require giving cash on hand to shareholders. The company could also keep the cash for expansion projects.

The board could declare and issue a stock dividend which puts more shares in the hands of shareholders effectively lowering the value of each share. This is done to encourage wider ownership and satisfy stockholders who want a dividend when the corporation needs to conserve the company's cash.

A third way is to repurchase shares on the market. This is done to increase the share value-- fewer shares on the market means an increase in value of each share or an increase in earnings per share (EPS). Some investors make investing decisions based on EPS. There are other reasons to repurchase shares, but affecting the share price is a common reason. Investors tend to see the buyback as a signal that earnings per share will increase thereby increasing share value on the market. The repurchase is sometimes used to award employees with bonus shares of stock.

Another way to affect the value of the stock is to report transparent, high-quality earnings. This growth will be over the longer term and will be reflected in an increased stock value/price over time.

First Post
Based on your current knowledge, present your recommendation to FunTime Inc. board of directors on how they could make their stock more attractive to investors. Support your recommendation and explain how it would be disclosed to investors?

Answer 1

Requirements of Funtime Inc:

1. The board is looking for ways to make its stock attractive to the investors.

2. The company is looking to expand and grow the company which means it requires more additional capital.

Following are the few main ways through which the comapny can fulfill its requirements mentioned above:

Now let us discuss the some of the pros and cons of the main ways through which the compny can fulfill its requirements.

(i) By Declaring Cash dividend:

Declaring Cash Dividend means paying the shareholders some part of its earnings as dividend in proportion to their respective shareholding in the comapny. It could either be paid as a percentage on the face value of the share or it could be an absolute amount. Though it certainly makes the stock of the comapny attractive to the investors, it also means that the company would be paying part of its earnings to the shareholders instaed of investing the earnings in various growth opportunities such as increasing its production capacity in the existing business or hiring talented employees at the top level management or entering into whole new sector of business which makes the comapny's business diverse and less risk prone to the external market factors which in turn makes the shares of the company strong and stable in the market.

Therefore, eventhough the cash dividend policy would make the stock more attractive to the investors,it is not recommended since the company is looking to expand and grow the company for which it actually needs cash in its balance sheet.

(ii) By Declaring a Stock Dividend:

Stock dividend can be issued in either by way of issuing bonus shares or by making a  rights issue.

Bonus Issue means issuing the shares to the existing shareholders at free of cost in proportion to their exisitng shareholding. This would result in higher number of shares without any change in capital or recevings which reduces the EPS of the company. Reduction in EPS would lead to a decrese in market price of the share which might give an opportuinity to the new retail investors to purchase the shares of the company at a lower price. This will satisfy the existing shareholders as they will have the higher ownership in the company and also fulfills company's requirements of capital to expand and grow the company.

Rights Issue means the offering the shares of the company to the existing shareholders at a price less than the market price i.e; offering shares at a discounted price. Again this will also satisfies the investors and also addresses the company's capital requirement to expand.

(iii) By way of Buy Back of Shares:

Buy Back means purchasing back the shares of company from the existing sharehoders at a premium price above the market price. This is another way of rewarding its shareholders. Though it will satisfy its existing shareholders, it would actually involves outflow of funds from the company's books instead of inflow. Therefore, this will not address the capital requirement of to make the grow and expand.

CONCLUSION:

From the above mentioned pros and cons of various ways to attract investors, i would recommend the Stock Dividend method as it would satisfy both parties the shareholders and also addresses the copamny's capital requirements.