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Id No. 0860103

MSc Management
Assignment Cover Sheet

Submitted by: 0860103

Date Sent: 15th April, 2009

Module Title: Corporate Finance (IB92C0)

Date/Year of Module: Jan – March, 2009

Submission Deadline: 15th April, 2009

Number of Pages: 2

Word Count: 1309

Question: [Question Number and Title, or Description of




“All the work contained within is my own unaided effort and

conforms with the University's guidelines on plagiarism.”
Id No. 0860103
Q1) The vote in favour of or against the Value Enhancement Plan (VEP) of Ford

It would not be advisable for Ford to go ahead with the VEP as proposed. This is attributed to the
following factors which will have considerable influence over the future of the firm in the light of this

Firstly, the VEP is extremely complicated and has a different proposition to offer to each investor
type in terms of tax liabilities, capital gains and future prospects of payout. For example, suppose there
is an investor having 50 shares of Ford initially and he decides to opt for the extra shares. The Ford
stock was trading at $46.73 in the July of 2000 as mentioned in the case. Thus, for each share, he
would get 0.748 shares which give him a total of about 37 shares more in total. Previously, the
dividend on a share was $2 giving him $100 as dividends. Assuming that the payout is unchanged,
Ford will now have to give a dividend of 100/87 = $1.15 per share. The price of Ford’s stock falls by
$20 which gives the price as $26.8, consistent with the payout as well.

The above analysis indicates that the VEP is a slightly modified stock dividend as the number of
shares has increased by about 1.6 and the price has been slashed by about 55%. If this were the
intention of the firm, then a simple stock split announcement would have been sufficient instead of
formulating an intricate and complex form of payout.

Alternatively, consider an investor who has preferred cash to getting more shares. For a holding of 50
shares, he would get $100 dividends. After the VEP, his holding will be worth 50*26.8= $1340
(instead of the earlier $2336) and he has $1000. According to the yield, the dividends received now
would be 50*1.15 = $57.5 which indicates a decrease of 43%. From the above, the $1000 received is
on similar lines to a stock repurchase. The plan is thus a situation of a stock repurchase since the
$1000 presented to the investor is at the expense of a reduced holding which can be achieved by
announcing a simple repurchase plan instead.

Secondly, there is also a considerable disparity in the returns to investors due to the issue of
securities taxation. As per the VEP, an investor deciding to choose more shares over cash will be
exempted from tax because the VEP in this case is a blueprint of a stock split. Moreover, he can also
benefit from the fact that capital gains tax can be deferred by a delayed sale of his shares. However, an
investor preferring the $20 will be liable to capital gains tax since it can be considered that one half of
each of their share has been sold. Hence, this differential taxation is another shortcoming of the
scheme. A repurchase or a dividend announcement on the other hand has a uniform taxation treatment
of all the shareholders.

Thirdly, the plan leads to a concentration of the voting rights of Ford whereby, (as mentioned in
the case) their voting rights would be maintained at 40% in spite of the stake being diluted to 3.6%
from 5% at the expense of individual investors. This coupled with the sale of common stock to class B
shareholders may not be received in a positive light in the long run by the stock markets as it may be
perceived as a compromise of corporate governance mechanisms of Ford. With the intention of the
board to tighten its grip on the firm to a greater extent, the market may react adversely to the VEP in
the long run if operating performance deteriorates. Apart from this, the VEP links managerial
performance to the share price of the company which influences managers to take decisions to keep
the stock price at a superior level. However, a number of decisions may not be salutary for the
company in the long in spite of superior short term performance.
Id No. 0860103
What Ford may consider….

A stock repurchase is more conventional and will benefit Ford in the sense that the information in the
announcement is relatively easy to interpret. It will be more effective in communicating to the
investors the undervalued state of Ford’s stock and the managerial confidence in buying back shares. A
dividend payout may not be advisable as Ford’s stock is already trading at a low level and the
subsequent drop due to dividend payout may not be advisable in the short term. Moreover, a stock
repurchase will serve the intent of the Ford family by further concentrating their stake as the number of
shares would be lower after the repurchase.

Q2) Individual Investor Preferences in the Event of the Implementation of the VEP

a) A Ford family member with class B shares

In this case, the preference would be a mix of shares and cash. The Ford member would prefer to
increase his stake in the firm by the extra shares that he entitled to. The intention would be to maintain
the superior voting rights shares at the current level and avoid class B stock dilution which would be
achieved in such a payout preference. For eg, if Edsel B. Ford II prefers to exercise his right to a
payout mix of either $20 or 0.748th of a stock, he will only get cash in the former case and securities in
the latter. But if he goes for the new option announced, i.e. the choice of a mix of the two in the form
of $5 cash and 0.56th of a share, he would receive $5*(245680+5633928)*(1-0.2) = about $23.2m of
cash (after capital gains tax) as well as 0.56*245680 = 137580 new common shares which gives him
an substantial amount of cash as well as Ford common stock and serves the family’s purpose.

b) An institutional investor such as TIAA-Cref or CALPERS

For such investors, a mix of shares and cash is preferred. This is because the philosophy of these
funds or trusts is to consider the dividends as income for short term expenditure while the invested
principal is ‘grown’ in the form of capital gains. Moreover, these investors can also afford to take
cash payouts as they are exempt from tax liability. However, if they take an all cash payout, the
worth of their holding will reduce drastically. An all stock payout leaves them with no cash to pay
to investors. Thus, a mix of stock and cash is optimal as the holding value will decrease by a minimal
amount but will yield cash to the fund in exchange which may be reinvested elsewhere. For instance,
consider CALPERS which has 6.5million shares of Ford worth $303.7 million in July 2000 at $46.73.
If CALPERS opts for a combination of $5 with 0.56th of a share, the holding value will marginally go
down from $303.7million with 6.5million shares to $271.7m with 10.14million shares. However,
CALPERS will also get $32.5million of cash which will not be taxed and which is attributable to its
investors at the present or available for reinvestment.

c) A Regular outside Shareholder

A regular outside shareholder would prefer to get a 100% cash payout of $20 per share. This is
because assuming the investor has 50 shares initially, a 100% cash payout provides him with $800 of
post tax income ((50*$2)*(1-0.2) as the cash is treated as capital gains) in the current year. This is as
high as 8 years dividend income in the pre VEP scenario!!!. Although the payout decreases to $1.15
from $2 in the next year with a concomitant decrease in the stake, the outside investor may not be
interested in ‘ownership’ as such since he has a lesser say in the day to day operations and only has
control over 1 voting right per share. The investor would prefer to make a superior gain by means of
the VEP and then be content with a lower payout in the future years.