January 10th, 2018
Determining the Optimal Dividend: Evaluating HCA Inc.’s Decision to pay a $ 1.75 Billion Dividend
A number of factors determine the amounts that a corporation pays out to its investors as dividends (return on investment). As early as 1956, John Lintner, proposed a common approach to dividend determination as summarized by Capital Partners Limited (henceforth CPL) learning module (2002, slide 7). Firms thus can have long-term targeted payout ratios; constant payout rates when managers are hesitant to change the dividends; payout rates that change in accordance with long-term sustainable earnings; or payout rates that focus more on changes rather than total levels of dividend (CPL, 2002, slide 7). Some of the important determinants of the dividend policy can thus be argued to be profitability of the company, cash flows generated, and the annual growth in sales at the company (Anil, & Kapoor, 2008). Other factors that are advanced to determine the amount of dividend a firm pays are corporate taxes and “market to book value ratio” (Anil, & Kapoor, 2008, p. 63).
These factors bear some significance in determining the dividend payout ratio. For instance profitability of the company is essential since dividends, by prudence, are paid out of the residual profits after charging expenses including interest and corporate taxes but never from capital (HM Revenue & Customs n.d). Further cash flows that a company has generated are also important in determining the amounts of dividend paid. Unless the payment of dividend is made in terms of shares (bonus issue or rights issue) to the existing shareholders; the company must posses adequate cash reserves to enable it pay the declared dividends since such payment is deemed to be effected either through cash or cash equivalents (HM Revenue & Customs n.d). Payment of dividends from reserves (part of shareholders equity) is also imprudent since in most cases the reserves are meant to finance contingent liabilities whose effect on performance is not immediately determinable but probable in future; act as a source of funds for expansion (growth) activities, and/ or serve as a source for the replacement cost of assets that have either been rendered obsolete or have been fully depreciated.
This paper aims to acquaint with how the determinants of dividend payout rate plays into the dividend payment decisions of corporations. To make such an analysis the paper looks into the credibility of the decision by HCA Inc. (hereafter HCA) to pay $ 1.75 billion to its private equity owners in its 2009 financial year (Wortham, 2010, January 29). The dividend payout was to be “funded through the company’s existing asset-based and general revolving credit facilities and cash on hand” according to the Nashville Business Journal news (Wortham, 2010, January 29). This paper evaluates the performance at the company by analyzing the trend in its incomes, profitability, cash flows and taxation on the company from 2005- 2009 to determine whether the decision to pay the large dividends was justifiable. Go to part 2 here.