George Liu, the CEO of Penn Schumann was a creature of habit.Every month he and Jennifer Rodriquez, the companyAc€?cs chieffinancial officer, met for lunch and an informal chat at PierreAc€?cs.Nothing was ever discussed until George had finished his favoriteescalope de foie gras chaude. At their last meeting in thoughtfullywith his glass of Chateau Haut-Brion Blanc before suddenly asking,Ac€A?What do you think we should be doing about our payoutpolicy?Ac€??Penn Schumann was a large and successful pharmaceutical company. Ithad an enviable list of highly profitable drugs, many of which had5 or more further years of patent protection. Earnings in thelatest 4 years had increased rapidly, but it was difficult to seethat such rates of growth could continue. The company hadtraditionally paid out about 40% of earning as dividends, thoughthe figure in 2011 was only 35%. Penn was spending over $4 billiona year on R&D, but the strong operation cash flow andconservative dividend policy had resulted in a buildup of cash.PennAc€?cs recent income statements, balance sheets, and cash flowstatements are summarized in Tables 17-4 to 17-6.The problem, as Mr. Liu explained, was that PennAc€?cs dividend policywas more conservative than that of its main competitors. Ac€A?Shareprices depend on dividends,Ac€?? he said. Ac€A?If we raise our dividend,weAc€?cll raise our share price, and thatAc€?cs the name of the game.Ac€?? Ms.Rodriquez suggested that the real issue was how much cash thecompany wanted to hold. The current cash holding was more thanadequate for the companyAc€?cs immediate needs. On the other hand, theresearch staff had been analyzing a number of new compounds withpromising applications in the treatment of liver diseases. If thisresearch were to lead to a marketable product, Penn would need tomake a large investment. In addition, the company might requirecash for possible acquisitions in the biotech field. Ac€A?What worriesme,Ac€?? Ms. Rodriquez said, Ac€A?is that investors donAc€?ct give us creditfor this and think that we are going to fritter away the cash onnegative-NPV investments or easy living. I donAc€?ct think we shouldcommit to paying out high dividends, but perhaps we could use someof our cash to repurchase stock.Ac€?? Ac€A?I donAc€?ct know where anyone getsthe idea that we fritter away cash on easy living.Ac€?? Replied Mr.Liu, as he took another sip of wine, Ac€A?but I like the idea of buyingback our stock. We can tell shareholders that we are so confidentabout the future that we believe buying our own stock is the bestinvestment we can make.Ac€?? He scribbled briefly on his napkin.Ac€A?Suppose we bought back 50 million shares at $105. That wouldreduce the shares outstanding to 488 million. Net income last yearwas nearly $4.8 billion, so earnings per share would increase to$9.84. If the price earnings multiple stays at 11.8, the stockprice should rise to $116. ThatAc€?cs an increase of over 10%.Ac€?? A smilecame over Mr. LiuAc€?cs face. Ac€A?Wonderful, he exclaimed, Ac€A?here comes myhomard a la nage. LetAc€?cs come back to this idea over dessert.Ac€??Evaluate the arguments of Jennifer Rodriquez and George Liu. Do youthink the company is holding too much cash? If you do, how do youthink it could be best paid out? Also, how much of the earningswould you consider paying to stockholder in the form ofdividend?Table 17-4 Penn Schumann, Inc., balance sheet (figures inmillions)2011 2010Cash and short-term investments 7,061 5,551Receivables 2,590 2,214Inventory 1,942 2,435Total assets 11,593 10,200Property, plant, & equipment 21,088 19,025Less accumulated depreciation 5,780 4,852Net fixed assets 15,308 14,173Total assets 26,901 24,373Payables 6,827 6,215Short-term debt 1,557 2,620Total liabilities 8,384 8,835Long term debt 3,349 3,484Shareholder’s equity 15,168 12,054Total liablities and equity 26,901 24,373Note:Shares outstanding, millions 538 516Market price per share ($) 105 88Table 17-5 Penn Schumann, Inc., Income Statement (figures inmillions of dollars)2011 2010Revenue 16,378 13,378Costs 8,402 7,800Depreciaiton 928 850EBIT 7,048 4,728Interest 323 353Tax 1,933 1,160Net Income 4,792 3,215Dividends 1,678 1,350Earning per share ($) 8.91 6.23Dividends per share ($) 3.12 2.62Table 17-6 Penn Schumann Inc., statement of cash flows (figures inmillions of dollars)2011Net Income 4,792Depreciation 928Decrease (increase) in receivables (376)Decrease (increase) in inventories 493Increase (decrease) in payables 612Total cash from operations 6,449Capital expenditures (2,063)Increase (decrease) in short-term debt (1,063)Increase (decrease) in long-term debt (135)Dividends paid (1,678)Cash provided by financing activities (2,876)Net increase in cash 1,510