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Case 4 Dividend Policy at FPL Group, Inc. (A)

Team members (G13): Mohammad Akramali 0227/52 Pasupuleti Shalini 0272/52 P.S.M Siddartha 0278/52 Priyanka Sarkar 0296/52

1. What are the main issues confronting FPL Group in May 1994? Which amongst those you identified are relevant to the dividend decision?         

With the deregulation in early 1994 brought a proposal by the State of California to the table introducing the notion of retail wheeling. As a result of retail wheeling initiative, California’s three largest utilities lost total of $1.8 billion in market value in one week. 23 other states began to consider variations of the California retail wheeling proposal. These proposals had a profound effect on the competitive landscape of the utilities industry. As of a result of this new competition, companies must reevaluate their business strategies to accommodate this new competitive environment and remain successful. A previously mature industry is now transforming into an industry with prospects for growth. FPL’s stock price has fallen by 19.6% while S&P index has decreased by 22.1% Despite selling / writing off several acquisitions, FPL still maintained ESI Energy, Turner Foods and Qualtec Quality Services Lawsuit from the Florida Municipal Power Agency is still ongoing and may have material impact to the firm’s operations Relevant to dividend decision-

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As a result of the now competitive landscape, Standard and Poor’s rating group announced a revision of its guidelines for evaluating investor owned electric utilities. Because of the competitive market, the dividend pay will be reduced as it will use the cash in positive NVP project. Factors in the new guidelines included customer and sales growth prospects, revenue vulnerability and dependencies as well rates by consumer class relative to competing utilities among others

2. From FPL’s perspective, is the current payout ratio appropriate? If not, what is appropriate? FPL’s current payout ratio(1994)= cash dividends/net income (2.47*191.5)/527 89.75%  According to exhibit 9, FPL has the highest payout ratio in comparison to other electric utilities in the same industry  With deregulation giving rise to competition FPL Group, Inc. needs to focus its operations and begin to grow its business in order to survive.

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By retaining only 9% of its earnings, the firm would find it very difficult to grow quickly without the expensive acquisition of capital. The current dividend payout ratio is too high considering the challenges the company will face in a deregulated and competitive environment. FPL currently maintains an inappropriate payout ratio. Given the situation that the new regulation will be soon implemented, FPL will face strong competition not only from Florida but also from all other states. To prepare for competition and sustainable growth in near future FPL should use its excess cash to invest in new positive NPV projects.

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Therefore FLP should not maintain high payout ratio at 107.3%. Instead it should lower to or below average ratio of industry which is around 82.9% since the dividend cut does not lower the firm value. 3. From an investor’s perspective, is the payout ratio appropriate? FPL investor Individuals 51.9% Institutions 36.9% ESOP 1.1% Individual Investors• It would be advantageous for individual investors to have FPL’s Dividend payout ratio at a lower level for the following reasons: –  Tax advantages: 28% capital gains tax Vs. Up to 39.6% personal income tax.  Possibility of stock repurchase plan in the future  Allows dividend payout ratio to grow in the future  Possibility for increase in stock price caused by higher growth rates. For individual investors the payout ratio has little meaning because they can use homemade dividend strategy to obtain capital gains rather than receiving high cash dividends and paying tax on them. Furthermore they do not need dividends to convert shares to cash. Institutions Investors For institutional investors, this payout ratio may be appropriate because they prefer high payout ratio in seeking for high earnings from their investment.  FPL has to increase the ratio over time to satisfy these investor’s expectations. 4. As Kate Stark, what would you recommend regarding investment in FPL’s stock? By calculating the share price which has increased due to the dividend pay cut .(excel sheet). So in the short run, as FPL does a dividend pay cut , investors will get a negative signaling and share price might go down.

So FPL should buy back the shares to retain its share price. But in the long run, the cash from the dividend pay cut will be utilized in positive NVP projects which will increase its share price. So the shares should be bought to gain a long term profit.