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WHAT HAPPENS TO THE FCFE THAT ARE NOT PAID OUT? - In 2003, Microsoft had FCFE...

WHAT HAPPENS TO THE FCFE THAT ARE NOT PAID OUT? - In 2003, Microsoft had FCFE of roughly $9 billion, paid no dividends, and bought back no stock. Where would you expect to see the difference of $9 billion show up in Microsoft's financial statements? EXPLAIN.

  • It will be invested in new projects.
  • It will be in retained earnings, increasing the book value of equity.
  • It will increase the cash balance of the company.
  • None of the above.
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Answer #1

FCFE, if not paid out, in the form of dividends or stock buyback, will be surplus cash for the company. Firms that do not have to make net debt payments for the given period, this surplus cash will add to the cash balance of the company. There can be a number of reasons why a company chooses to retain surplus cash:

1). The company may not be sure about its future financing needs and so, saves cash to meet unexpected financing needs.

2). The company may be facing major fluctuations (high volatility) in the earnings and so, may prefer to save cash in order to meet dividend payments over time.

3). Sometimes, bondholders can impose restrictions on the payments made to shareholders (as per the terms of the bond indenture).

4). Managers of the company may prefer to build up cash as a means to increasing the size of the company.

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