MFT Plc Case Scenario

MFT Plc is a money management firm based in the U.K. One of MFT’s funds invests in companies with effective corporate governance and conservative capital structures. Rollo Martin, a newly hired analyst, prepares a presentation for the MFT investment committee. Before screening potential investment opportunities, Martin asks his supervisor Hugh Crabbin how to identify effective corporate governance structures and systems. Crabbin states that Martin should look for the following corporate governance attributes:

• Transparency in disclosures;

• Measurable performance accountabilities;

• Directors identifying strongly with managers’ interests.

Martin gathers information on a potential investment, France-based TML S.A. The company’s website provides details of its corporate governance, some of which is presented in Exhibit 1.

Exhibit 1

Extract from TML S.A.’s Corporate Governance Information

After reviewing this information, Martin is concerned about TML management’s ability to receive excessive compensation. In addition to TML’s corporate governance, Martin analyzes the company’s capital structure. He observes that it has a low debt-to-equity ratio relative to its peers. Martin determines the unlevered value for TML to be €2,000,000,000. He makes the estimates shown in Exhibit 2 to assess the impact of leverage on TML’s capital structure.

Exhibit 2

Selected Leverage Scenarios for TML S.A.

Carol Reed, MFT’s chief investment officer, is interested in TML’s dividend policy. TML uses a longer-term residual dividend approach and currently earnings are near the cyclical high. Martin explains that in the past the company has kept its cash dividend stable despite rising earnings. Moreover, he believes that the recent increase in earnings is only temporary. In addition to paying cash dividends, the company has a share repurchase program. Reed does not agree that much of the increase in TML’s earnings is temporary. She wants to know from Martin what the expected dividend of TML would be if the company used a 5-year period to adjust the dividend towards a target payout ratio of 40 percent. Martin uses TML’s regular dividend per share of €0.50, last year’s earnings of €2.50 per share, and current year’s anticipated earnings of €3.0 per share to calculate the expected dividend.