According to the Ford Motors balance sheet, it may seem that it indeed does have too much cash reserves. However, in deciding whether or not the company has too much cash, several factors will have to be considered. Companies hold cash for various reasons, chief among them the financing of routine transactions of the company, meeting covenants with lending institutions and other debtors, for speculation purposes and as a source of flexibility in the operations of the company.
Cash reserves held by Ford are high for the reason that the company intends to conduct a value enhancement plan. Such a move requires a high level of cash reserves, and it is only appropriate that the company should have high levels of cash reserves. After making this consideration, it is possible to conclude that the company does not have too much cash because the high cash reserves are as a result of planned and gradual moves with a specified intention with a specified motive. It can thus not be claimed that Ford Motor Company has excess cash.
The cash reserves held by the Ford Motor Company are meant for the restructuring of the shareholding of the company through a value enhancement plan. This is a deliberate move by the company that demands an investment in large amounts of cash since one of the offers that the company will make to its existing shareholders will involve making actual cash transfers in the process of changing ownership structure of the company. From this argument, it is evident that Ford does not have too much cash. Rather, it has the level of cash reserves necessary for the value enhancement plan.
How does the VEP work?
A value enhancement plan has two key components; shares repurchase and a share split. The currently existing shares are exchanged in a specified ratio. Shareholders are also offered an option to reinvest a particular amount of cash to receive new shares.
The Ford Motor Company will be intended to make an alignment of the interests of the various shareholders by making an offering of different alternatives, a choice of $ 20 in cash, additional new common stock or a combination of cash and new shares. The existing shares that are will be exchanged on a one-for-one basis and also an offer made to the shareholders to reinvest $ 20 to receive an additional common share of the company. Through this method, the share price of the company will decrease while the number of the shares of the company is going to increase. As per the company’s plan, the shareholders who make a choice of the share option will receive 0.748 new common shares of the company in place of $ 20. Those shareholders who choose to receive cash will receive $ 20 for the shares they forgo, and thus this will be similar to a share repurchase.
What are the alternatives for distributing cash?
Value enhancement plan is one of the methods that a company can use for distributing cash. The other common method used by companies to distribute cash to shareholders is through payout in dividends. The company declares a dividend, usually an interim and a final dividend per each common stock held. This is paid out to shareholders in the form of cash which is credited directly to shareholders. However, this method of cash distribution is tax inefficient since it is on the earnings after taxes declared by a company. Dividends are also subject to a withholding tax which reduces the earnings of the shareholders.
Share repurchase is another method of cash distribution. It is conducted by offering cash in exchange for the shares held by a company. This occurs when a company needs to make a restructuring of its shareholding without having to go through a share split or a share reissue. It may be undertaken by offering to reduce a percentage of the shareholding of a company by making cash offers to shareholders for the exchange.
A value enhancement plan is another method for distribution of cash. It offers a combination of both a share repurchase and share split. Shareholders are offered the alternative of either accepting the number of shares that they have to be split in a predefined ratio or to forgo this increase in their shareholding by receiving cash payment of a predefined amount of cash, which in itself translates into a feature of share repurchase. This is the method that the Ford Motor company has chosen to use in its cash distribution. By opting for a value enhancement plan, the company will be able to change the shareholding structure of the company while at the same time making a distribution of cash.
What problems is the VEP plan designed to solve?
The major problem that the value enhancement plan intends to solve is changing the performance of the company’s stock in the stock market. The company, prior to the value enhancement plan, was performing dismally in the stock exchange and the company was employing the value enhancement as a way of reinforcing the performance of the company. It is thus expected that the plan would improve the performance of the shares in the stock market, and a resultant increase in the market value of the company. Improved performance in the stock exchange would lead to easier sourcing of investment funds from the market to finance the operations of the company.
The value enhancement plan will also play a central role in satisfying the needs of the various classes of shareholders. The Ford family has previously enjoyed control of the company and the value enhancement plan will contribute towards further consolidation of this control. The family’s ownership in the company will be strengthened through this plan, and thus their interests will be better protected after implementation of the value enhancement plan. Institutional investors in the company will also be able to strengthen their position by making acquisition of the improved share value in the company.
The company will be able to do away with its high cash reserves. High amounts of retained earnings that are reflected in the balance sheet affect the profitability ratios of the company such as the return on assets and return on equity. In the industry that Ford operates, the profitability ratios are very significant because the companies operating under the industry are prone to the negative effects of cyclical economic cycles. The value enhancement plan will thus go a long way in ensuring that the company’s profitability ratios improve and thus make it possible to attract more investors to financing the company’s activities.
The company’s large cash reserves were also in a period when the market place for acquisitions was not very promising. This meant that the company could not invest the large cash reserves in a significant acquisition which would propel the company’s performance in profitability and revenue growth in the long term. Therefore, using the cash reserves on the value enhancement plan was the most appropriate method of using that cash in the most tax effective way both to the shareholders and the company.
As a shareholder, how would you approve the VEP? Would you elect cash or shares?
As a shareholder, I would approve of the value enhancement plan. This decision would be informed by the fact that the move would have the long term effect of increasing the value of the shares of the company in the stock market. This would have a personal effect on my wealth in the company since such long term increases in the market value of the shares would translate into capital gains attributable to me as an investor.
As an investor, the value enhancement plan would also present an opportunity of earning tax effective earnings. The cash option of the plan would mean that the payments received would be treated as capital gains and would not be taxed. This is a much better option than receiving such payments as dividends which would not qualify as tax exempt.
In making a choice, I would elect the cash option. This is because I would still have the same number of shares with better prospects in the stock market and thus a higher potential for capital gain. The cash provided would be a cheap source of funds which can be invested in other stocks in the stock market as a way of diversifying my holdings and thus spreading the risk.
References
Weston, J. F. & Eugene F. B, Managerial Finance, 2010. New York, NY: Cengage Learning.
Brigham, Eugene F., Fundamentals of Financial Management .1995. New York, NY: McGraw Hill.
Blazenko, G. W., "Corporate Leverage and the Distribution of Equity Returns," Journal of Business & Accounting (October 1996), p. 1097-1120.
