Question

At the end of its June 30, 2008, fiscal year, Microsoft Corporation reported $23.7 billion in short-term interest-bearing investments and cash equivalents. The firm had no debt obligations. Subsequently, in September of that year, the firm announced a $40 billion stock repurchase and its intention to raise the annual dividend to 52 cents a share, from 44 cents, or to a total of $4. 7 billion.

Cash flow from operations for fiscal year 2009 was projected to be $23.4 billion, up from $21.6 billion for 2008; interest receipts were expected to be $702 million; and the firm was expected to maintain cash investment at the 2008 level of $3 .2 billion. Cash receipts from the issue of shares to employees were expected to be $2.5 billion. The firm's tax rate is 36 percent.

a. By applying the treasurer's rule, lay out the strategy for Microsoft's treasurer for managing cash flows.

b. Microsoft is actively looking for acquisitions to enhance its presence in the Web search and Web applications area. What would be the effect on the treasurer's plan if Microsoft decided to make a $4.2 billion cash acquisition?

c. For many years, Microsoft has carried no debt (obligations). At the time of the share repurchase announcement, Microsoft also said that it had received authorization from its board of directors for debt financing up to $6 billion. Why would the management seek such authorization at this stage?

Answer 1

Part (a)

Let's first prepared an abridged cash flow statement for the treasurer to figure out how cash flows will look like for the year. Please see the table below. Cash flows are in $ bn. A figure in parenthesis means a negative value. The column titled "Linkage" explains how each value has been calculated. IN the first column, there is a sign like [+] or [-] before each item which will help you understand whether a line item / value is added or subtracted to get the final value.

Expected Cash flow statement for the treasurer for 2009
Parameter	Linkage	$ bn
Cash flow from operations	A	23.40
[+] Interest receipts	B	0.70
[-] Taxes on interest received	C=36% x B	0.25
[-] Cash investments	D	3.20
[+] Proceeds from issue of shares	E	2.50
[-] Dividends to be paid	F	4.70
[-] Share repurchase	G	40.00
Expected cash flow during the year 2009	A + B - C - D + E - F - G	(21.55)

There will be a cash shortfall of $ 21.55 bn. There are three possible strategies for the treasurer, based on the cash flows statement shown in the table above:

1. Redeem the $ 23.7 billion in short-term interest-bearing investments and cash equivalents it has on its balance sheet as June 2008 and use the same to bridge the cash flow gap.
2. Raise fresh debt to bridge the cash shortfall.
3. A combination of option (1) and (2)

Part (b)

If Microsoft decided to make a $4.2 billion cash acquisition, the revised cash flow position will be $ (21.55) - $ 4.2 = $ (25.75). So the shortfall will further increase. The treasurer will have to necessarily resort to fresh debt because even after redeeming the full $ 23.7 billion in short-term interest-bearing investments and cash equivalents, there will still be shortfall.

Part (c)

It would not take Microsoft long to realize that there will be cash shortfall next year, primarily driven by share repurchase program. We have seen a negative cash flow for the year in the table above, on a gross basis. The timing of the cash flows may make the gap even larger. The cash acquisition pipeline will further increase the gap. It's therefore wiser on the part of the management to be prudent and proactive; and seek and receive authorization from its board of directors for debt financing up to $6 billion.