Spending Earnings

1
chapter 15

• Spending Earnings

Lonni Steven Wilson, Medaille College
2
Key Chapter Objectives

• Describe different types of dividend policies and
  how they are used.
• Describe how a business utilizes retained
  earnings.
• Understand how mergers and acquisitions are a way
  for a sport business to expand.
• Describe the legal concerns associated with
  mergers and acquisitions.

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Key Terms

• dividend paymentsPayments made out of earnings,
  in the form of either cash or stock, to a
  business owners or shareholders (Brigham
  Ehrhardt, 2005).
• distributionsSimilar to a dividend but paid out
  of sources other than current or accumulated
  retained earnings.
• retained earningsCompany keeps earnings for
  capital investment and forgoes paying
  shareholders.

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Decisions About Using Earnings

• The right decision about using earnings selects
  the option that will produce the greatest value
  to the
• Ownership or to the
• Shareholders (in the case of a publicly owned
  company)

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Methods of Using Earnings

• In general, sport businesses have three choices
  for using earnings
• Pay dividends to shareholders, if it is a
  for-profit business
• Retain earnings for reinvestment in the business.
• Reinvest in other firms by purchasing a
  percentage or acquiring other firms outright.

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Views on Making Dividend Payments

• The first method of dealing with earnings is to
  pay dividends. Three views exist on how to pay
  dividends
• Pay the highest possible dividend.
• Make a middle-ground dividend payment, somewhere
  between high and low, that will satisfy most
  shareholders.
• Pay the lowest possible dividend.
• (Brealey, Myers, Marcus, 2004)

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Buying Back Stock

• Companies may opt to buy back stock as a means of
  repaying investors (i.e., instead of continuing
  to pay dividends).
• Results
• The number of shares outstanding decreases
• The book value per share increases
• Reasons a company may buy back stock
• Distribution of earnings (instead of issuing a
  dividend)
• Change capital structure

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Paying Stock Dividends

• Companies may pay stock dividends in lieu of
  cash.
• Potential negative resultsA dividend paid in
  stock can have a dilutive effect on share price.
• Potential positive resultsStockholders may save
  money on taxes.
• (continued)

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Paying Stock Dividends (continued)

• Capital gains versus income tax how shareholders
  may save
• Cash dividend payments are taxed as income for
  shareholders.
• Money earned from the sale of stock is taxed as
  capital gains.
• If stockholders sell the new stock within one
  year of owning it, they are taxed 28 (as of
  January 2006) on their gains.
• However, if stockholders sell the new stock after
  more than a year of ownership, they are taxed
  only 15 on their gains.
• On the basis of taxation policy, many
  stockholders would prefer the repurchase of stock
  over dividend payments (Brealey, Myers, Marcus,
  2004).

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Retaining Earnings

• The second method of dealing with earnings is to
  retain earnings.
• Dividend payments cannot exceed retained earnings
  on a business balance sheet (impairment of
  capital rule).
• Considerations in the amount of retained earnings
• A business capital structure, capital budgeting
  decisions, and dividend policy
• A business size
• Target capital structure (proportion of debt to
  equity)
• Managerial control

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Reinvesting in Other Firms

• The third method of dealing with earnings is to
  reinvest in other businesses, which takes one of
  two forms
• Mergers
• A merger is the combining of two or more
  businesses into one.
• One business blends its business with the
  acquired business.
• Acquisitions
• In an acquisition, the acquiring company
  maintains control over the acquired company and
  serves in a dominant position over it.
• The two businesses remain their own distinct
  companies.

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Types of Mergers

• Horizontal Two companies in the same line of
  business are joined.
• Vertical A buyer expands operations forward
  toward the final customer or backward toward the
  source of raw materials.
• Upstream markets (closer to raw materials)
• Downstream markets (further down in the
  production process closer to customer)
• Conglomerate Companies in unrelated lines of
  business come together.

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An Example of a Sport Company Acquisition

• An excellent example of a companys acquiring
  another business in an attempt to increase its
  own value is News Corporation, owned by Rupert
  Murdoch.
• News Corporation operates television networks
  such as the Fox Network, Fox Sports, and BSkyB.
• As part of an overall business strategy, News
  Corporation acquired the Los Angeles Dodgers for
  311 million in 1998 (Chass, 1998).
• One reason for the purchase was to provide
  broadcast content for the companys television
  networks.
• (continued)

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An Example of a Sport Company Acquisition
(continued)

• Therefore, although the Dodgers may not have been
  a company that provided large profits, Murdochs
  goal was to use them to help his other business
  ventures such as television and radio
  broadcasting.
• Interestingly, Murdochs goal of using the Los
  Angeles Dodgers to generate profits for his other
  holdings in broadcasting failed to materialize.
• In 2004, Murdoch sold the Dodgers to real estate
  mogul Frank McCourt for 430 million.
• (Frew, 2004)

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Questions for In-Class Discussion

• Is consolidation in the sport industry good?
• Do you think it would be worthwhile to create
  another football league similar to the United
  States Football League or the XFL? Would another
  baseball, hockey, or basketball league be a
  better investment?
• If you could make 10 from a government bond or
  10 from investing in a professional sports team,
  which one would you invest in and why?
• If you had this responsibility within a
  corporation, under what circumstances would you
  make a decision to reinvest versus issuing a
  dividend?