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The study of Florida Power and Light Company (FPL) is to determine if a company's value can be affected by the negative signals of dropping its dividend levels. Our recommendation is to buy FPL stock, even though its stock price fell 6% after the market analysis of its dividend cut prediction. It is true that dividends signal company's future value and market reacts inversely. But FPL was a special case because it was a healthy company that cut its dividend.

It is instinctive to consider FPL's business environment when it made the dividend announcement. The two reasons that lead FPL to cut its dividend were: the recent speed of deregulation in the utilities industry that forced FPL to start thinking about the impact of not being a regulated company, and the fact that the dividend payout had grown to a higher than normal level on a historical basis. The average EPS growth rate from 1984 to 1993 was only 0.9%, but the Dividends Per Share growth rate was 3.8%, which was much faster than the company's earnings. (See Exhibit 4b)

There are two theories about dividends usually used to explain the market response to the company's dividend policy. One is Signaling Hypothesis. This theory is based off the idea that managers have better information about a firm's future prospects than public stockholders do. Since future dividends are paid out of future profits, and given that managers are reluctant to cut dividends, any change in dividends to be paid is often viewed signal of future profits. Thus, increases in dividends generally result in stock price increases and cuts in dividends generally result in stock price declines. This is theory that most of the market analyst based on when they issue their opinions on FPL.

Comparing to the early 90's, FPL had taken $5.8 billion capital expenditure program and financed through issuance of $3.7 billion long-term debt and $1.9 billion common stock. From the Cash Flow statement, we can see FPL has been issuing nearly as much new stock as it has been paying dividends to meet its expansion needs. Moreover, operating cash flow has nearly been enough to finance capital expenditures. Facing these crises, the 5- year budget in Exhibit 6 has reflected James Broadhead's new strategies of cutting operating quality control and diversification programs cost. FPL shows strong and steady growth in its sales, market share and operation capacity. Its net income has an average of 7.7% annual increase. And its capital expenditure has decrease about 11% annually. Also EPS has an average growth rate of 4%, which contribute to increasing net income and slower increasing of outstanding shares. If FPL kept its $2.48 dividend per share rate, its pay out ratio would drop below 80% by the end of the five years. If FPL cut its dividend to $2.23, 90% of prior dividend level, it would drop below 80% right in the second budget year. In order to keep the same payout ratio, FPL would end up paying 2.91 per share. This would contradict with the management's goal and lead FPL into financial stress. These results support that FPL's plan to adapt itself to become more of a growth company in an unregulated environment from an income company with a monopoly in its market. The significance of this case is that FPL was the first company to drop the dividend payout without the typical negative reasons, but for strategic reasons. The market temporary price decline from the dividend cut was a false interpretation of the company's strategic change. This market movement created a buying opportunity for

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